Question

Consider the market for Drug A, which is produced by a price-taking firm that receives a price of $100 from the industry market and decides, considering only private costs, to produce a quantity of 200 units. These decisions were guided by the firm’s goal, as always, to maximize its profits.

A government regulatory agency is contacted about significant water pollution that occurs as a result of production of Drug A. The agency examines the market and concludes that the social marginal cost for Drug A is $120 per unit when 200 units are produced. It further concludes that, were social and private costs both considered in making the output decision, 150 units would be produced instead of 200. The government therefore requires the manufacturer to produce 150 units instead.

Answer the following questions:

1. Draw a graph for the firm described, including all of the above information.
2. Calculate the reduction in total spending that occurs when the quantity produced changes from the amount the firm originally wanted to produce to the amount recommended by the regulatory agency.
3. Calculate the reduction in social costs that occurs when the quantity produced changes from the amount the firm originally wanted to produce to the amount recommended by the regulatory agency.

Answer 1