1. (8 points) Consider the market of fossil fuel vehicles. The value consumers get from buying fossil fuel vehicles determines the market demand, and production costs faced by producers determine the market supply. The market equilibrium is depicted in Figure 1. Figure 1: Market of Fossil Fuel Vehicles Price Supply Demand Vehiclex (Million) On a T.V. interview, Petra Lundberg, a well known environmental activist, gave the following statement: The use of fossil fuel vehicles produces local air pollution and contributes to global warming. However, con- sumers of fossil fuel vehicles do not internalize this fact when determining their willingness to pay for these vehicles. Therefore the market equilibrium is not efficient and the government should intervene. (a) Explain this statement given your knowledge of welfare economics and the Ten Principles of Economics. Is this statement a contradiction to Principle 6? view, Petra Lundberg, a well known environmental activist, gave the following statement: The use of fossil fuel vehicles produces local air pollution and contributes to global warming. However, con- sumers of fossil fuel vehicles do not internalize this fact when determining their willingness to pay for these vehicles. Therefore the market quilibrium is not efficient and the government should interuene. (a) Explain this statement given your knowledge of welfare economics and the Ten Principles of Economics. Is this statement a contradiction to Principle 6? (b) Government officials took notice of Petra Lundberg's suggestion and decided to intervene the market of fossil fuel vehicles by creating a tax to consumption of $1,500 per unit. Show graphically the effects of such a tax (c) Someone pointed to the fact that producers are also part of the problem, and therefore the government should put a $1,500 tax to the production of fossil fuel vehicles instead of the tax to consumption. Would this be a better policy? 3