Microeconomics 2nd Edition by Douglas Bernheim

Exercise 1

Repeat Worked-Out Problem 20.1 assuming that A = 40. Repeat the problem again assuming that A = 130. Based on your answers, explain what happens to the socially efficient level of production and the deadweight loss as the marginal external cost becomes larger at every level of production.

Worked-Out Problem 20.1

Figure 20.1 A Competitive Equilibrium with a Negative Externality. Figure (a) shows that, at a price of $1,000 per ton, a mill would produce 250,000 tons of paper. If the mill took external costs into account, it would produce only 100,000 tons of paper. Figure (b) shows the competitive equilibrium with 200 mills: a total of 50 million tons of paper is produced and sold for $1,000 per ton. It also shows that the socially efficient level of paper production is 30 million tons. The area of the red triangle represents the deadweight loss created by the externality.