Refer to the below competitive market diagram for product Z.Assume that the current market demand and supply curves for Z are D₂ and S₂.If there are substantial negative externalities associated with the production of Z, it can be argued that: A)a price lower than B and an output greater than G would improve resource allocation. B)government should levy a per unit excise tax on Z to shift the demand curve to the right. C)government should levy a per unit excise tax on Z to shift the supply curve toward S₁. D)government should subsidize the production of Z to lower equilibrium price and increase equilibrium output.

Question

Quizplus · Accepted Answer

When there are negative externalities associated with the production of a good, the market equilibrium output will be greater than the socially optimal output as the cost of the externality is not taken into account. To internalize this cost, the government can levy a per unit excise tax on the producers of the good, which will increase the price of the good and reduce the quantity demanded. This will shift the demand curve to the left, closer to the socially optimal level of output. However, this may not be enough to reduce the output to the socially optimal level as the supply curve remains unchanged. Therefore, the government should also shift the supply curve to the left by levying a per unit excise tax on the producers. This will increase the cost of production, leading to a decrease in the quantity supplied and a shift of the supply curve towards the socially optimal level of output. Overall, option C is the best choice as it suggests a combination of demand and supply-side policies to internalize the cost of the externality and improve resource allocation.

Refer to the Below Competitive Market Diagram for Product Z