Question

Suppose the market for oranges is perfectly competitive and unregulated. Suppose also that the chemicals used to keep the oranges insect-free damage the environment by an estimated $1 per bushel of oranges.

a) Suppose QD = 2000 - 200P and QS = -200 + 200P. The total dollar value damage to society is?

b) Suppose QD = 2000 - 200P and QS = -200 + 200P. The price consumers would have to pay for the market to achieve the socially optimal level of production is?

c) Suppose QD = 2000 - 200P and QS = -200 + 200P. The tax that would have to exist to achieve the socially optimal level of production would be

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Answer 1

(1) Solving the demand and supply equations we get market equlibrium quantity bought and sold as

Q= 2000-200P = -200+200P

      2200 = 400P

      P = 5.5

     Q = 2000-200 (5.5) = 2000 - 1100 = 900

Hence Total dollar value of environmental damage is $1*900= $900

(2) Here, the consumers will face a supply curve that incorporates a $1 tax to Government. Thus. Qs= -200+ 200(P-1) because the supplier will get a realisation of $1 less from the price paid by the consumers.

So, new equlibrium will be given by Q= 2000 - 200P = -200+ 200(P-1) or, 400P = 2,400.

So the price would be $6.

Hence demand would be Q= 2000-200(6) = 800. This would be the socially optimal level of production.

(3) Optimal amount of environmental damage would be $1*800= $800 but now govt. has collected $800 and they can use this money to reduce environmental damage elsewhere through mitigation effects and net environmental damage could be less tha $800.