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PS11 - Rice University ECON 211 Fall 2007 Problem Set 11...

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1 Rice University ECON 211, Fall 2007 Problem Set 11 Due on Thursday/Friday, December 6/7 1. Assume that the demand for automobiles is p=20,000-20q and that automobiles are produced in a perfectly competitive market where externalities exist. Firms perceive their supply to be S private =112+2q . On the other hand, government agencies have found MC pollution =q . a) Solve for the level of output produced and price charged in the absence of government intervention. b) Solve for the socially optimal level of output (may not work out to a whole number) and price. c) Draw a graph; indicate the values you calculated in parts (a) and (b). Also shade in and calculate the value of deadweight loss due to overproduction. d) What per unit tax will efficiently internalize the externality? That is, what per unit tax will shift the market supply so that the after tax equilibrium quantity is efficient? e) Discuss the problems with the per unit tax approach. For example, is the socially optimal level of output achieved if the demand for automobiles increases? 2. Suppose that a firm’s marginal cost of pollution abatement is 2+8q and the marginal benefit of pollution abatement is 1478-10q , where q is the pollution reduction in percent. a) Solve for the optimal level of pollution abatement. b) Calculate the cost to the firm to achieve the optimal level of pollution abatement.

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