Question

In: Economics

On 1 May, an environmental tax on plastic bags was introduced in Sweden. The tax is...

On 1 May, an environmental tax on plastic bags was introduced in Sweden. The tax is 3 kronor per plastic bag and has made the plastic bags in grocery stores about twice as expensive as before. The tax has been criticized for being too high since some say that the environmental benefits are not that large from using less plastic bags in Sweden. Assume a market with environmental damage due to a negative external effect.

The demand curve is P=9-Q. The supply curve (firms aggregate private marginal costs) is P=1+0.5Q. The marginal excess damage is constant and equal to 2.

a. Calculate the price and quantity on a free market. Also calculate the consumer surplus, producer surplus, the environmental damage and net welfare.

b. Now assume an optimal chosen Pigou tax is introduced. Calculate the new price and quantity on the market. Also calculate the new consumer surplus, producer surplus, the environmental damage, other effects and net welfare.

c. Now assume the environmental tax is set too high, say it is set to 3. Calculate again the price and quantity on the market, the consumer surplus, producer surplus, the environmental damage, other effects and net welfare.

d. Compare the difference between the outcome in b and c. Who loses and who gains from the incorrect environmental tax?

Expert Solution

1) free market Equilibrium at, demand= private supply

9-q=1+0.5q

8=1.5q

Q=8/1.5=16/3

P=9-8/1.5=11/3

CS=1/2*16/3*(9-11/3)=8/3*16/3=128/9

PS=1/2*16/3*(11/3-1)=8/3*8/3=64/9

External damage=2*16/3=32/3

Net welfare=128/9+64/9-32/4=32/3=10.67

B)pigou tax will be Equal to external marginal cost.

So

Tax= 2$ per unit.

New supply after tax,

P=1+0.5q+2=3+0.5q

New Equilibrium,

9-q=3+0.5q

Q=6/1.5=4

P=9-4=5

CS=1/2*4*(9-5)=2*4=8

PS=1/2*4*(5-3)=2*2=4

External damage=2*4=8

Tax revenue=2*4=8

Net welfare=8+4-8+8=12

C)New supply after new tax,

P=4+0.5q

New Equilibrium,

9-q=4+0.5q

Q=5/1.5=10/3

P=9-10/3=17/3

CS=1/2*10/3*(9-17/3)=5/3*10/3=50/9

PS=1/2*10/3*(17/3-4)=5/3*5/3=25/9

External damage=2*10/3=20/3

Tax=3*10/3=10

Net welfare=50/9+25/9-20/3+10=35/3=11.67

D)The pigou tax lead to social Optimal outcome because the net welfare of society is MAXIMIZES with pigou tax. But with tax of 3$ per bag will lead to a lower net welfare of society.

The incorrect environment tax losses CONSUMERs,producers and society.and it benefit goverment by generating more tax receipt.

Rahul Sunny answered 8 months ago

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