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Provide Graph and more explanation The production of paper creates pollution, an external cost. What happens...

Provide Graph and more explanation

The production of paper creates pollution, an external cost. What happens to the production of paper if the government imposes a tax on paper producers equal to the marginal external cost of the pollution? [Hint: Explain the changes step by step with graph illustration]

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Answer #1

Due to pollution, an external cost is imposed on the market in the form of pollution.

This will shift the marginal private cost to the left by amount of external cost, making it the marginal social cost curve.

Free market equilibrium is Qp and Pp

Social market equilibrium is Qs and Ps

When a tax equal to marginal external cost is imposed, the MPC curve will shift to the left to MSC (as external cost = tax)

As a result of this, output will reduce to the social optimal level Qs, thereby making the tax an optimal tax.

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