Question

3) The mayor of Vitaminville just received a new report that citizens who take a proper supplement of vitamin Z actually reduce the air pollution in the city with no other side effects.

a) The mayor recalls some of his economics course in college and realizes that this is a positive externality. He wishes to increase the amount of vitamin Z consumed in the city. Also recalling that quantity demanded increases when price decreases, the mayor proposes setting a binding price ceiling in this market. Graph the effect of this policy.

b) Does this policy accomplish the mayor’s goal?

c) The mayor decides he needs some help with his policymaking and hires you for advice. What would you suggest for him to do? Is there any downside to your policy?

Answer 1

Ans. a) The graph of the binding price ceiling has been drawn in the photo attached.

Kindly go through it.

Ans. b) No.

Though, Demand for product will increase because of decrease in price but this will be not gainful for suppliers.

Because for suppliers/producers the decrease in price than the market equilibrium price will result in loss of gains from the trade.

Hence this will bring shortages in supply and also reduction in quality of product.

Further Shortages and quality reduction will lead to inefficiency in distribution.

Hence, this will not fulfill Mayer's goal completely.

Ans. c) As an Economist I will suggest him following:

1. Approach government legally and request for Tax Cut in production of this Vitamin Z product;

2.submit the proof of this result, and also narrate the benefits of this product that how it is creating positive externality to society and also helping to reduce the Air pollution without any side effect.

3. Further I will show the effect of tax reduction graphically to the Mayer of vitaminville.

Where decrease in tax will be gainful to producers and if price ceiling is imposed still there will be no dead weight loss.

As can be seen in the graph.

Supply curve will shift to right, because of decrease in tax rate, which will increase the demand for product.

Hence in this case goal of mayer will be satisfied.

There will be one downside of this suggestion that tax revenue of government for this product will decreased but at the cost of social and environmental benefit.