Suppose that a wood pulp mill is situated on a bank of the River Tay. The private marginal cost (MC) of producing wood pulp (in £ per ton)

is given by the function MC = 10 + 0.5Y where Y is tons of wood pulp produced.

In addition to this private marginal cost, an external cost is incurred. Each ton of wood pulp produces pollutant flows into the river which cause damage valued at £10. This is an external cost, as it is borne by the wider community but not by the polluting firm itself. The marginal benefit (MB) to society of each ton of produced pulp, in £, is given by MB = 30 - 0.5Y

a. Draw a diagram illustrating the marginal cost (MC), marginal benefit (MB), external marginal cost (EMC) and social marginal cost (SMC) functions.

b. Find the profit-maximising output of wood pulp, assuming the seller can obtain marginal revenue equal to the marginal benefit to society derived from wood pulp.

c. Find the pulp output which maximises social net benefits.

d. Explain why the socially efficient output of wood pulp is lower than the private profit-maximising output level.

e. How large would marginal external cost have to be in order for it to be socially desirable that no wood pulp is produced?