You have been hired by the town of Bedford, Ohio, to conduct an analysis of ongo

Question

You have been hired by the town of Bedford, Ohio, to conduct an analysis of ongoing operations by a local Coca Cola bottler. A study by the Ohio Environmental Protection Agency found that this firms’ water pollution is negatively affecting the environment. The study has been read by several politicians and they have requested the state government to impose a tax. Politicians expect to observe a decrease in the environmental damage (specifically, eliminate the deadweight loss).

Your task is to find the optimal tax that the government should impose to this Coca Cola bottler. To help you in your task, you are given the following information:

Inverse Demand: P = 10 - Q
Inverse Supply (Marginal Private Cost): MCP = 5 +QExternalityCost(MarginalCostofExternality):MCE = 0.5Q

1. Determine the optimal tax (the Green Tax) the state government should charge the local Coca Cola bottler to deal with the negative externality. Hint: To find this, measure the difference between the socially optimal equilibrium price (P*) and the price the firm receives at the socially optimal equilibrium quantity (Q*), that is,MCP(Q = Q*). (3 points)

Explanation / Answer

The equilibrium of the market will be determined by equating supply and demand curves

10-Q=5

or

Q=5 and P=5

Now if the external social costs are taken into account then

MPC*= 5+ 0.5*5 =7.5

Now the equilibrium will be 10-Q=7.5

or Q=2.5 or P=7.5

Thhe Green Tax= 7.5-5 =2.5.

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