Question

The paper industry is the major industrial source of water pollution. The inverse demand curve for the paper market (which is also the marginal benefit curve) is P = 450 - 2Q where Q is the quantity consumed when the price consumers pay is P. The inverse supply curve (also the marginal private cost curve) for refining is MPC = 30 + 2Q. The marginal external cost is MEC = Q where MEC is the marginal external cost when the industry releases Q units of waste.

Using the information above explain why a ban on paper production may not be a good policy to address the water pollution.

Answer 1

At market equilibrium: Demand will be equal to the supply

450-2Q = 30 + 2Q

4Q= 420

Q= 105

So, P = 30 +2*105 = 240

Now, at social optimal point:

MB = MPC + MEC

450-2Q = 30 +2Q + Q

5Q = 420

Q = 84

So, Ps=30 + 3*84 = 282

Government can introduce tax on paper industry to reduce the production of the paper. It is a negative externality and introducing tax will lead from market equilibrium to socially efficient point. So banning the paper industry is not a good decision.