Question

3. Assume that a chemical plant in your area has been dumping its toxic waste free of charge into a local stream.

A. What is the criterion that we use to define “static economic efficiency”? Why would the market allocation not meet this economic efficiency criterion?

B. Use a supply and demand (i.e., marginal benefit-marginal cost) diagram to compare the market allocation (price and quantity) with the socially optimal (i.e., statically efficient) allocation.

C. How could you use a marketable permit system to solve this problem? Explain.

D. How could you use Pigovian taxes to solve this problem? Explain

Answer 1

A)We use total social welfare as criterion ,to definitely economic efficiency.If market leas to maximize the social welfare,it is efficient.else it is inefficient.

Because dumping toxic into steam, result in external damage cost to people,who use that water.so there is external cost associated with chemical plant production.

But because chemical plant doesn't consider this external cost,which result in firm to produce more than economic efficient quantity.

That why it is not efficient.

B)

Where, PMC is private marginal cost and SMC is social marginal cost,which is sum of PMC and marginal external cost.

C)The Government can issue permit to firms equal to social efficient quantity.each permit gives firms to pollute one unit of pollution.

By this, government restrict firms pollution to social efficient pollution.

This is a command and control approach to reduce pollution.

D) Government set tax equal to marginal external cost at social efficient quantity.

Firms need to pay this pigovian taxnoer unit for each unit of pollution emission.

By this ,firm private marginal cost shift to social marginal cost.,so which result in market to produce social efficient quantity.