FIGURE 12-3

-Refer to Figure 12-3, which represents the market for pulp, the production of which creates dioxin emissions. Suppose the market is currently producing at the profit maximizing point and the government wishes to impose a tax to correct the overallocation of resources caused by the externality. What per unit tax would accomplish this goal?

Question

FIGURE 12-3
 
-Refer to Figure 12-3, which represents the market for pulp, the production of which creates dioxin emissions. Suppose the market is currently producing at the profit maximizing point and the government wishes to impose a tax to correct the overallocation of resources caused by the externality. What per unit tax would accomplish this goal?

Quizplus · Accepted Answer

To correct the overallocation of resources due to the externality, the government needs to impose a per unit tax equal to the marginal external cost, which is the difference between the social cost (private cost + externality cost) and the private cost. 
In this case, the private cost is $80 (the supply curve), and the externality cost is $20 (the vertical distance between the supply curve and the social cost curve at Qm, the profit-maximizing quantity). Therefore, the social cost is $100 ($80 + $20). 
The per unit tax should be equal to the marginal external cost at the profit maximizing quantity, which is the upward shift of the supply curve due to the tax. 
From the graph, we can see that a per unit tax of $40 (the vertical distance between the new supply curve and the old one at Qm) would correct the overallocation of resources and shift the market to the socially optimal outcome where MSC = MPB. Thus, the correct answer is C.

FIGURE 12-3 -Refer to Figure 12-3, Which Represents the Market for Pulp