Question

1. The production of cars leads to more cars on the road and more pollution in the air. Graph the MC, MSC, and MSB of cars.
   1. Now label the efficient and inefficient market equilibriums, quantity and price.
   2. Show the DWL.
   3. What are 3 ways we overcome the inefficiency in the market?
   4. Show graphically how a tax can overcome the inefficiency in the market?

Answer 1

The increase in the production of cars leads to more cars on the road and more pollution emitted by them in the air. The fig below shows the Marginal Cost(MC), Marginal Social Cost(MSC), and Marginal Social Benefit(MSB).

On the y axis we have the price and on the x axis we have the quantity which is no of cars on the road caused by the increase in the production.

(A) Here we see that MC cuts MSB curve at point a showing quantity q₀ and price p_{0 ,} at price p₀ quantity q₀ is supplied. This is an inefficient equilibrium because here we didn't consider the Social Cost bear by the society from of the pollution of the cars on road

The efficient equilibrium will be point b in the figure below where MSB curve cuts MSC curve. Here, the price increased from p₀ to p₁ which reduces the quantity of the cars to q₁ from q₀ . Now , with reduction in the cars the pollution is reduced   

(B) Dead Weight Loss (DWL)

The DWL is shown in the figure below the triangle abc, because with this level of production MSC of the last unit is not equal to the MSB of last unit. This shows the Dead Weight Loss

(C) Three ways we overcome the inefficiency in the market

1. Polluter Pay Principle

The PPP is to make the party responsible for producing pollution responsible for paying the damage done to the natural environment. This will remove the inefficiency in the market by either reducing the pollution or paying the amount according to the pollution damage a person done.

2. Pollution Tax

The government can levy tax on the pollution for the efficiency because it is the sole purpose. Tax can also be put on the Cars produced by the Firms which may result in the increased price of Cars and demand for cars will reduced ultimately cars on road will reduced and also the pollution

3. Pollution Permits

When the pollution is hard to reduce, government can issue pollution permits which gives a person/firm a legal right to pollute a certain amount. The aim of pollution permits is to provide market incentives for firms to reduce pollution and reduce the external costs associated with it.

(D) How tax can overcome the inefficiency in the market?

By using tax on the product,(take example of cars) it intended to make consumers/producers pay the full Social cost of the good. Tax on the product will reduce the consumption and bring a more socially efficient outcome in the market.

If the external cost of driving a car is $2 per mile, then this is how the tax on petrol prices should be calculated.

A good with a negative externality, without the tax , there will be over consumption where demand equals supply because generally people ignore the external costs attached with them

It is shown in the figure below

After the tax is levied on the good, quantity reduces from Q₁ to Q₂ which is socially efficient .

Hope my answer helped you. Thank You