*4. Gasoline brings great benefit to those who buy it, but burning it also creates external costs.

Consider the graph below, which shows the demand for gasoline, the private marginal cost of producing gasoline, and the social marginal cost of producing gasoline.

a. Suppose that buyers and producers of gasoline do not consider the external marginal costs they impose on others. Determine the equilibrium quantity and price; then use the letters in the diagram to fill in the appropriate spaces in the table below:

b. Suppose that conscientious sellers, out of the sheer goodness of their hearts, decide to incorporate external marginal costs into their production decisions. Determine the new quantity (Hint: Use the social marginal cost curve) and price, then use the letters in the diagram to fill in the appropriate spaces in the table on the previous page. (Be sure to remember that producer surplus is the area above private marginal cost and below the price, out to the relevant quantity.)

c. Producers rarely do something out of the goodness of their hearts, and are likely to consider only their private marginal costs.
Compare total surplus in both cases to determine the deadweight loss of the externality when external marginal costs are not considered.

Transcribed Image Text:

Price ($/gallon) P P2 22 A D H B F G C E SMC MC D Q2 Q1 Quantity of gasoline