Gobbet_8_Externalities_Solution_Problem_Set

Gobbet_8_Externalities_Solution_Problem_Set - Gobbet #87:...

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Gobbet #87 : Externalities: Solution (These problems are adapted from Callan and Thomas: Environmental Economics and Management , 2004) Recall the demand and supply schedules for the bottled water market. PRICE (P) Quantity Demanded by Consumers (bottles/month) Quantity Supplied by Producers (bottles/month) $0.50 1,100 100 1.00 1,050 300 1.50 1,000 500 2.00 950 700 2.50 900 900 3.00 850 1,100 3.50 800 1,300 4.00 750 1,500 4.50 700 1,700 5.00 650 1,900 Now assume that the bottles in which the water is sold are creating pollution. In fact, for each discarded water bottle, society would have to pay $1.00 to abate the pollution the bottle causes.
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SOLUTION: Graphically show the marginal cost curve and the social marginal cost curve. The marginal cost curve is simply the inverse supply curve you found in earlier gobbets. To determine the social marginal cost curve, we add the amount of the pollution cost to the marginal cost curve. This, in effect, shifts the marginal cost curve upward (or, equivalently the supply curve to the left). Graphically we have: Marginal Cost and Social Marginal Cost Curves 0 4 8 12 0 500 1,000 1,500 2,000 Bottles of Water Price Marginal cost curve Social marginal cost curve Find the equation that corresponds with the social marginal cost curve. (Remember that the marginal cost curve is also called the inverse supply curve.) Recall that the equation for the marginal cost curve (also called inverse supply) is: MC = 0.0025 Q s + .25 To obtain the social marginal cost (SMC) curve, we add the cost of the externality to this equation: SMC = 0.0025 Q s + .25 + 1.00 = 0.0025 Q s + 1.25 Note that by adding 1.00 to this equation, the intercept shifts up by this amount, and thus every point along the marginal cost curve also shifts up by 1.00
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Gobbet_8_Externalities_Solution_Problem_Set - Gobbet #87:...

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