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The inverse demand for newsprint can be described by P=200−QP=200−Q
The inverse demand for newsprint can be described by P=200−QP=200−Q. The private marginal cost of producing newsprint is MCP=140+QMCP=140+Q. The total external cost (from water-borne pollution is a simple linear function of the quantity of newsprint (and its co-products) produced, so the marginal external cost is MCE=QMCE=Q. What is the amount of a specific tax (tax per unit of newsprint produced) will induce production of the socially-optimal quantity of newsprint?
A. Optimal Tax per unit of newsprint = $20
B. Optimal Tax per unit of newsprint = $15
C. Optimal Tax per unit of newsprint = $12
D. Optimal Tax per unit of newsprint = $10
E. Optimal Tax per unit of newsprint is different from any of the above
Expert Solution
The correct answer is: A. Optimal Tax per unit of newsprint = $20.
Given that;
P=200−QMC=140+QExternal cost=QP=200−QMC=140+QExternal cost=Q
The government should tax the newsprint amount equal to external damage caused. This will shift the marginal private cost (marginal cost curve) upwards and to the left along the demand curve (marginal social benefit). Optimal output will occur at a point where the marginal social benefit is equal to marginal social cost:
MSC=MPC+EE=TMSC=MPC+TMSC=MSBMSC=140+Q+Q140+Q+Q=200−QQ=20T=Q=$20
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