Question

17.10. The demand for widgets is given by P = 60 - Q. Widgets are competitively supplied according to the inverse supply curve (and marginal private cost) MPC = c. However, the production of widgets releases a toxic gas into the atmosphere, creating a marginal external cost of MEC = Q.

a) Suppose the government is considering imposing a tax of $T per unit. Find the level of the tax, T, that ensures the socially optimal amount of widgets will be produced in a competitive equilibrium.

b) Suppose a breakthrough in widget technology lowers the marginal private cost, c, by $1. How will this affect the optimal tax you found in part (a)?

Answer 1

On the analysis of the case in relation to Demand and supply of widgets, the case deals with the subject matter of Externalities, there are Following Observation noted.

a) The production of Widgets resultants in releasing Toxic Gases, thus the matter shall be covered in pollution rights, there is a need to cover in quotas and emission control so to counter negative externalities.

b) The tax shall be imposed equal to MEC. It may result in Internalizing the externalities, thus to ensure Socially Optimum level

Answers

Part - (A) The level of tax imposed by Government shall be equal to MEC, that will ensure the socially Optimum amount of widgets that will be produced in a competitive equilibrium.

Part - (B) In that case, the government shall ensure subsidies equal or higher that MPC and impose taxes also thus equalize the impact and the impact lies equal or above Break-even point.