Question

Supply Demand

MC = P = 20 + 0.5Q MB = P = 200 – Q

1. What is the equilibrium price and quantity in this market?

2. Suppose the market described above is characterized by a negative externality. Which of the following best describes the negative externality concept?

3. Suppose the market described above is characterized by a negative externality. Which of the following is the best example of a negative externality?

4. Suppose the market described above involves a $30 marginal external cost for every unit produced. What is the socially optimal price and level of production in this market?

5. In markets characterized by a negative externality, we often say that the private market price (or the unregulated market price) is too low. What is meant by this?

6. Suppose the government observes the market described above and passes a rule that production in the industry cannot exceed 100 units. This would be an example of what type of policy approach?

7. Suppose instead the government decided to charge an emissions fee of $20. Why might policymakers prefer a fee over a simple decree that production cannot exceed 100 units?

8. Suppose the government decided to charge an emissions fee of $20. As firms adjust their behavior in response to this fee, will outcomes be socially optimal?

Please answer only 5,6,7,8. Thank you

Answer 1

Question 5

In markets characterized by a negative externality, the private market price is too low.

This means that private market price is not reflecting the true cost of production. Negative externality is not taken into account while determining the cost of production.

Exclusion of negative externality is keeping cost down leading to lower market price.

If cost of negative externality is taken into account then cost of production would increase. This will lead to reflection of true cost and would result in higher price.

Thus, non-accounting of negative externality leads to too low private market price in the market characterized by a negative externality.