Chapter 16 Examples
4. Use the figure below, which shows the linear demand and constant cost conditions facing a
firm with a high barrier to entry, to answer the following questions.
a.
The profit-maximizing price is $________, and the firm will produce ________ units.
The firm earns economic profit of $________.
b. Suppose antitrust officials find a way to remove the entry barrier to this market, and the
market becomes perfectly competitive. Assuming that demand and cost conditions
remain the same, what price and quantity will result? How much consumer surplus will
buyers in this market gain?
c. How much deadweight loss is caused by the market power created by the high entry
barrier?
8. The figure below shows the marginal damage (MD) curve and the marginal abatement
cost (MAC) curve facing an industry that discharges a pollutant into the environment.
a.
If environment regulations do not restrict pollution by this industry, the industry would
discharge ________ tons per month. At this level of emissions, total damage caused by
pollution would be $________ per month, and total abatement cost would be $________
per month. Total social cost of pollution in this industry would be $________ per month
in the absence of any government restrictions on pollution.
b. If environmental officials banned all pollution, forcing the industry to eliminate all
pollution discharges, then total abatement cost for the industry would be $________ per
month, and total social cost of zero pollution in this industry would be $________ per
month.
c. Why is zero pollution in this industry not optimal from society’s point of view? Explain
carefully using the figure above.
d. The socially optimal level of emissions for this industry is ________tons per month,
which results in a total abatement cost of $________ per month, and total damage from
pollution of $________ per month. Total social cost is $________ per month.
e. At the optimal level of pollution in part d, exactly what is maximized or minimized?
f. What is the optimal level of abatement from society’s point of view?
g. If environmental authorities wished to control pollution in this industry by imposing an
emission tax on pollution, the tax per ton of discharge should be set at $________ per
ton. At this tax rate, the industry discharges ________ tons per month and pays a total tax
bill of $________ per month. The industry abates ________tons per month and incurs a
total abatement cost of $________ per month.
Answers:
4. To answer this question, you must first construct the firm’s marginal revenue curve, as
shown in the figure below:
a. MR = MC at 15,000 units, so the firm maximizes profit by producing 15,000 units at a
price of $17.50. The firm’s profit is $112,500 [= ($17.50 – $10)  15,000)].
b. Since competition will force price down to $10 in long-run equilibrium and output will
increase to 30,000 units. In moving to long-run competitive equilibrium at point C,
consumers will gain the area of trapezoid gfCM, which is $168,750 [= $7.50  ((15,000 +
30,000)/2)].
c. The deadweight loss caused by the market power is the area of triangle bCM, which is
$56,250 (= 0.5  15,000  $7.50).
8. The figure below provides answers to various parts of this question.
a. 4,000; $80,000; $0; $80,000. The uncontrolled level of pollution is 4,000 tons per
month. Total damages at 4,000 tons is $80,000 per month (= area 0st = 0.5  4,000 
$40). Total abatement cost is $0, because no abatement is undertaken at 4,000 tons
(point t). Total social cost, which is the sum of total damage and total abatement cost, is
$80,000 (= $80,000 + $0).
b. $240,000; $240,000. Total abatement cost = $240,000 per month (= area 0rt = 0.5 
4,000  $120). Total social cost, which is the sum of total damages and total abatement
cost, is $240,000 (= $0 + $240,000).
c. Zero emissions is not the optimal level because the marginal cost of abating the 4,000th
ton is $120 while the marginal benefit of doing so is $0 (i.e., MD = 0 for the 4,000th ton
abated). Therefore, emissions should be increased (and abatement decreased) until
MAC = MD at 3,000 tons per month.
d. $15,000; $45,000; $60,000. Total abatement cost is $15,000, which is the area vte (= 0.5
 1,000  $30). Total damages are $45,000, which is the area 0ve = 0.5  3,000  $30.
Total social cost is $60,000, which is simply the sum of total abatement cost plus total
damages (= $2,000 + $4,000).
e. Total social cost of pollution is minimized at 3,000 tons of monthly discharge.
f. The optimal level of abatement for this industry is 1,000 tons per month, which is the
difference between the uncontrolled level of pollution, 4,000 tons, and the optimal
level, 3,000 tons.
g. $30; 3,000; $90,000; 1,000; $15,000. The emission tax should be set at the intersection
of MD and MAC, which is $30. Profit-maximizing firms will increase emissions up to the
point where the cost of abating another ton is exactly equal to the emission tax (MAC =
e), which occurs at 3,000 tons in this case. Industry will pay $30 per ton on 3,000 tons
for a total monthly tax bill of $90,000. The industry abates 1,000 tons for a total
abatement cost of $15,000, which is the area vte (= 0.5  1,000  $30).