but you should also see that W* => area lga
=> (1/2)(350)(100) = 17,500
=> W* = 17,500
A common mistake was “PS* = 12,500” (perhaps representing the area ghl).
Recall that producer surplus
is the difference between price received and marginal cost ,
over the actual quantity sold
. It is often a triangle, but
produces at a level where the private marginal cost equals private marginal revenue:
TR = P(Q)Q = (400 - Q)Q = 400Q - Q
Marginal Revenue MR =
= 400 - 2Q
Equilibrium Quantity => MR = MC =>
=> 400 - 2Q = 40 + 2Q
Equilibrium Price => 400 - Q
=> 400 - 90 => 310
Remember that the
is the welfare deficit, relative to the socially optimal level.
Consumer's Surplus, CS
(400 - 310)(90)(1/2) = 4,050
(90)(270 + 90)(1/2) = 16,200
Total external cost, TEC
elfd => (90) (10+55)(1/2) = 2,925
Total Welfare, W
= 4,050 + 16,200 – 2,925 = 17,325
also see that W
=> area acde minus elfd is alcf => (1/2)(350+35)(90) = 17,325
Deadweight Loss => DWL
= W*- W
= 17,500 – 17,325 = 175
also see that DWL
=> area agl minus alcf
is cgf => (1/2)(35*10) = 175
The government plans to intervene with a tax or a subsidy to shift the private MC curve so that it intersects the MR
at the desired optimal level of output Q*.
Let's call "x" the amount by which the MC curve should change.
way we have written the equation, a negative value for x implies a subsidy (reducing MC), while a positive value
implies a tax (increasing MC).
MC(Q*) + x
(40 + 2 Q*) + x =
(400 - 2 Q*)
We know from a) that Q* = 100, so x is the only unknown.
40 + 2(100) + x =
400 - 2 (100)
240 + x = 200
x* = - 40.
The government should thus grant the monopolist a unit subsidy of $40 per unit produced.
This seems strange---
subsidizing a polluter—but the intuition is simple. Relative to the social optimum, the market power of a
monopolist make her produce “not enough” (and charge too high a price), but the unregulated externality makes her
produce “too much”, so the two effects work in opposite directions.
If the externality is relatively severe, the
government should encourage the monopolist to restrict even further its production by charging a tax. But if the