2 Use the figure below to answer the fellowing questions PCs

2. Use the figure below to answer the fellowing questions PCs Si (8,1 105 9… 20 75 90 Q (Tons) Suppose that this product produces pollution to the society A. Which curve represents a private cost and which curve represents a private benefit? points) B. If the products are provided by private markets, what are the equilibrium price and quantity? (2 points)

Solution

(A)

S2 is the curve representing private cost.

D is the curve representing private benefit.

(B)

For the private market, relevant demand and supply curves are D and S2.

Private market equilibrium is where D intersects S2 at price of $70 and output of 90 units.

(C)

If the cost of pollution is considered, social equilibrium is where D intersects S1 at price of $90 and output of 75 units.

Deadweight loss = (1/2) x Difference in price x Difference in output

= (1/2) x $(90 - 70) x (90 - 75)

= (1/2) x $20 x 15 = $150

(D)

Pollution is a negative externality. To reduce negative externality, a tax is imposed.

Amount of tax is the vertical distance between S1 and S2 curves at private equilibrium point, that is, amount of tax per unit = $(105 - 70) = $35 per unit