3. The firms in a particular competitive industry produce one unit of pollution

Question

3. The firms in a particular competitive industry produce one unit of pollution along witlh each unit of their output. A government could tax the producers on each unit of their output. Alternatively, it could give each firm a certain number of permits and allow the firms to trade permits, while requiring that they own a permit for each unit of output they produce. Possible private and social marginal cost curves (PMC and SMC) and social marginal benefit curves (SMB) for the industry are shown in Figures 2 and 3 below. For each part of this problem, remember to write in brackets the most closely related notes, page and paragraph number a. Describe the way the marginal damage varies depending on the output level in Figure 2. What type of pollution could have this type of variation in marginal damage? Explain b. Describe the way the marginal damage varies depending on the output level in Figure 3 Explain c. In each Figure, mark and label the competitive equilibrium output level Qe and the (socially efficient) output level e that maximizes total surplus. EXPLAIN why these quantities are where you marked them in the graphs. d. In each Figure, show an efficient tax per unit of output that the government could charge the firms in order to lead them to produce a total of Qe units of pollution in competitive equilibrium. Show how the demand or supply curve shifts as a result of the tax, drawing the new curve as a broken curve. EXPLAIN why the tax you drew has the effect on supply or demand that you drew in Figure 2. e. In each Figure, show an efficient number of tradable permits that the government could give the firms in order to lead them to produce a total of e units of pollution f. In which case (Figure 2 or 3) will the most efficient tax not change much if there is a big shift in the SMB curve vertically up and to the right? EXPLAIN ost per output outpu output output

Explanation / Answer

As we know that polluting firm(Eg. Air polluting) creates negative externality of production, it means that social costs are more than social benefits.

As shown in the following figure, Marginal Social costs(MSC) are more than Marginal private costs(MPC) as olluting firms affect those people od bio life which is not a part of business decision.

Economic output QE is more than market desired Q* and prices for private people PE are lower than optimum Price P *.

b) If firm produces more output then social costs will be more as marginal private costs will keep on decreasing and marginal social costs will keep on increasing. MPC will shift to right amd MSC to left

c) In the figure P * and Q* are social optimum prices and quantity respectively. To achieve this a tax on output by polluting firms is necssary. This way MPC will shift to the left and prices will also go from PE to P*. Total demand will also shift to Q* and new equilibrium is achieved which is social optimum.

d) tax should be MPC+tax=MSC (causing MPC to shift up towards MSC) This happens as tax increases firm gets lesser price per unit of output as whatever customer pays a part goes to government as tax and when producers get less money then they will be discouraged to produce less. Also the fact that higher prices will discourage customers to consume less.

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