Suppose there are four sellers and four buyers in a market. Each seller sell one unit of output. The opportunity costs of producing one unit are given by $7, $5, $3, and $1 for seller 1,2,3,and 4 respectively. Each buyer demands one unit of output. The willingness to pay for one unit of output are $12, $10, $8, and $6 for buyers 1, 2, 3 and 4 respectively.
1) If for each unit of output produced an external cost of $4 is incurred by a third party then calculate the level of deadweight loss associated with the perfectly competitive allocation. If a tax of $4 per unit is imposed on the perfectly competitive market then does this tax create or eliminate deadweight loss? By how much?
2) Now suppose that there are no externalities but that the government levies a tax of $1 per unit. If the market is perfectly competitive then what is the level of deadweight loss created by this tax? What if the tax was 44 per unit?
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