Legal Studies 145 - Law and Economics I
Answers to P
ROBLEM
S
ET
#4
1. The marginal benefit and marginal cost curves are shown in the figure below. The
efficient solution minimizes the sum of the total harm and total cost of removal, which
can be determined as the percentage of removal at which the marginal benefit (MB)
equals the marginal cost (MC). The intersection at point D tells us the level of removal.
Solving algebraically, MC = 10P = MB = 6-2P, yields P = .5
2. Firms now must add to the cost of removal (5P
2
) the payment of damages (4(1-P)+
(1-P)
2
, and minimize the sum of both. The firm can do this by choosing a P such that its
marginal cost of removal is equal to its marginal reduction in damage payments. Since
the
latter is given by MB, the firm can internalize the cost of emission by choosing the P
where
MC = MB.
This is socially efficient. Another way to work this out is to use the calculus

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