11. Market solutions to correct for negative externalities Aa Aa This problem as

Question

11. Market solutions to correct for negative externalities Aa Aa This problem asks you to examine the costs and benefits in the market for petrol in Sydney. The marginal social benefit from the consumption of petrol is equal to the sum of the private benefit and any externa benefits received by other members of society. The marginal social cost of consuming petrol is equal to the sum of the private cost and any external costs imposed on other members of society. Assume that there are no external benefits generated by the use of petrol. Therefore, the private benefit is equal to the marginal social benefit. The cost of consuming petrol comes in two parts. First, the driver pays the market price for petrol. In addition, other people who live in the area bear a cost, because they suffer from the pollution created by consuming petrol; this is the external cost of consuming petrol. Because external costs result from the consumption of petrol, the marginal social cost of a litre of petrol exceeds the private cost. The following graph shows the demand for petrol, the private cost of a litre of petrol, and the marginal social cost of producing and consuming petrol. PRICE IDollars per litrel MSB MSC 10

Explanation / Answer

Without, government intervention, equilibrium price will be 3 and consumption will be 40 untis.

True statements are:

Market outcome is not socially efficient.

MSC is greater than private cost.

This intervention will automatically correct the externality.

Imposition of tax: $1 on 20 liters.

Both the policies. ( But i guess tax will be more efficient as quantity restrictions will lead to smuggling and other illegal activities).

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