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Unformatted text preview: the production of each unit of blecch produces enough air
pollution to cause $2 in damages. The production of blecch is taxed at a
rate of $10 per unit.
 (a) Draw a partial equilibrium diagram illustrating this initial situation and
indicate the quantity with the tax (QT ), free market quantity (QM ) and
the socially optimal quantity (Q∗ ), respectively. Be sure to label the
curves in the diagram. P
Q  Q Q* QM (b) Do partial equilibrium welfare analysis of a proposal to replace the $10
tax with a subsidy of $2.
• Draw a new diagram to reduce the clutter because you can leave
out the lines associated with the market equilibrium and socially
• Your ﬁnal welfare change may be messy, so you don’t need to determine whether it is positive or negative. Please do try and simplify
it (via cancelling). 4 P
A E P2 F B P3 MC
H D P4
MSB Q ∆CS
Q T Q (A + B + C + E + F + G + I + L)
(B + C + D + F + G + H + K )
−(B + C + F + G + K + L + M ) − (A + B + C + D(35)
−(G + H + I + J + K )
E + F − (J + K + M )
(37) If you drew this to scale, it would be clear that this is positive.
 (c) State whether welfare would rise or fall if the initial tax ($10) was
reduced to $6. Very brieﬂy explain the intuition behind your answer.
Note: You do not need to draw a diagram OR do welfare
analysis of this case!
Welfare would rise. The intuition is that the $6 tax is moving us closer to
the optimal tax of $2. 5...
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This note was uploaded on 01/17/2014 for the course BUSINESS 121 taught by Professor Na during the Fall '12 term at Wilfred Laurier University .
- Fall '12