Dr. Shishkin
ECON 2106
Assignment #13
ANSWERS
Externalities. Part I.
This figure shows the market for fertilizer.
When fertilizer is applied to lawns, it runs off
into neighboring streams and ponds, killing fish
and creating an external cost. (Assume that the
number of parties involved and the transaction
costs are too high for the private solution of the
externality problem.)
1. What is the equilibrium price and quantity of fertilizer in an unregulated, competitive
market?
6 tons per day
2. What is the efficient quantity of fertilizer?
4 tons per day
3. What is the deadweight loss borne by society if the externality is left uncorrected?
DWL=0.5x(1600-1000)x(6-4)=600 dollars per day
Suppose government imposes a tax equal to the marginal external cost.
4. What is the equilibrium price paid by consumers and the equilibrium quantity after
implementation of the tax?
P=$1,200, Q=4 tons per day
5. At the output level in part (4), how much is the tax per one ton?
Tax = $400 per ton
6. How much tax revenue does government collect?
Tax revenue = 4 tons x 400 tons per day = $1600 per day
Email me at [email protected], and text at (678) 524-5535 if I don’t respond
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Dr. Shishkin
ECON 2106
Suppose there are two firms in an area, each emitting 200 tons of sulfur as a result of
their production. The government decides on a target level of 200 tons of sulfur in the
area, and gives each firm a permit to emit 100 tons of sulfur. Suppose Firm A can reduce
pollution by 100 tons at cost of $500. Firm B has an older plant, so it can reduce pollution
by 100 tons at cost of $1,000.
7. What is the lowest price that firm A will be willing to sell its permit to firm B?
$500
8. What is the highest price that firm B will be willing to pay for a permit that would
allow it to emit 100 tons of sulfur?
$1000
9. What kind of deal firms A and B are likely to strike, if the firms are allowed to trade
their permits? Explain how this deal can benefit both firms.
A will be willing to sell its permit at a price that is above $500 because it can
spend $500 to get rid of its waste and keep the difference. Firm B will be willing to buy a
permit at a price that is lower than $1000 because by purchasing a permit it can avoid
spending $1000 to get rid of the waste. Both firms are likely to trade a permit as firm A
will be selling its permit to firm B at a price that is between $500 and $1000.
Email me at [email protected], and text at (678) 524-5535 if I don’t respond
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