Question

4. Let's say that the market demand curve for gasoline is Q = 100 - P (however, P is price, Q is quantity), and that the private cost curve of the gasoline supply industry is MC = 10 + Q. And suppose that the marginal cost curve due to the marginal damage of pollution from gasoline supply is MEC = Q.

(a) First, calculate and graph the market balance of the price and sales of this gasoline market when there is no regulation on environmental pollution.

(b) And calculate and graph the price and sales volume as a socially desirable balance of gasoline market reflecting the effects of external damage of gasoline.

(c) Calculate how much tax the government should impose to correct this external recession in the gasoline market.

(d) Calculate and compare the total amount of consumer surplus, producer surplus and environmental damage costs from the balance above A and B respectively. Which side's total surplus is greater when defined as "social surplus = consumer surplus + producer surplus - environmental damage cost"? Also, express these differences in the size of social gross surplus in area in the picture.

Answer 1

a) Equilibrium in unregulated market occurs when MC = Demand

10 + Q = 100 - Q

Q = 45

At this Q, P = 55

b) Equilibrium in regulated market occurs when MC + MEC = Demand

10 + Q + Q = 100 - Q

Q = 30

At this Q, P = 70

c) Tax must be vertical distance between MSC and MC at output level of 45 which is 100 - 55 = 45

d)

Regulated market:

Cosnumer surplus is area of portion A whose sum is (1/2) * (100 - 70) *(30 - 0) = 450

Producer surplus is area of portion B + E whose sum is (1/2) * (70 - 10) *(30 - 0) = 900

Unregulated market:

Cosnumer surplus is area of portion A + B + C + D whose sum is (1/2) * (100 - 55) *(45 - 0) = 1,012.5

Producer surplus is area of portion E + F + G whose sum is (1/2) * (55 - 10) *(45 - 0) = 1,012.5

Deadweight loss is area of portion H whose sum is (1/2) * (100 - 55) * (45 - 30) = 337.5

Unregulated market total surplus is greater than regulated market.