2. The COVID-19 pandemic is an example of an externality which a ects all economic activities. Consider a particular sector of the economy which has suppliers, demanders, and potential victims of externality. Assume that the demand, which is both the private and social marginal benefit (PMB=SMB), is given by P = 120Q , private marginal costs (PMC) are given by P=Q and that marginal external costs (MEC) are given by P= Q.

(a) Draw a numerically accurate supply and demand diagram for this industry. Find the equilibrium output, Q0, consumer price,P0c and producer price P0p0, that occur when the industry ignores the externality. Now add to your graph the social marginal cost curve,P= M EC+P M C. Suppose the government imposes a Pigouvian tax, t* on output. Find the Pigouvian tax ,t*, output Q, and the consumer and producer prices, Pc and Pprespectively. Show both equilibria on your graph. Find numerical values for all prices, taxes, and quantities and show each on your graph.

b) For both equilibria, identify as areas on your graph (lettered A,B,C,. . . ) and calculate numerically the following: consumers surplus, CS,, producers surplus, PS, total external costs, TEC= (1/2) x MEC x Q, government Pigouvian tax revenues, GTR=t* x Q*, and total welfare, W=CS+PS +GTR- TEC. Identify as areas on your graph and calculate the numerical values for the following: net social welfare, W* at Q*, the dead-weight-loss,DW L0 at Q0, the TEC at Q and the TEC0 at Q0, on your graph.

(c) Plot a numerically accurate graph of the net private marginal benefit of consumers and producers together, NPMB= PMB- PMC, and the marginal external cost to victims.Identify Q0 and Q* on this graph. Relate the four triangles on this graph to the areas on your graph from part (b). Label the areas W* , DWL0, and TEC on your graph and show their numerical values. There is a fourth triangle on this graph, which is the increase in total private benefits of producing Q0 rather than Q*. Label this area (triangle) TPB0, explain what areas of your graph from part (b) it corresponds to, and find its numerical value.

d) Suppose that instead of a Pigouvian tax solution, government officials decide either to let the market be (i.e., to hold firms or consumers legally not liable for the external costs their consumption or production choices may make, the Swedish model) or to simply ban the activity (e.g., the US and Canadian models). Call these solutions N L (not liable) and B (ban), respectively. Then explain what policy is optimal under the following conditions regarding transaction costs, T C? (i) T C < DWL0 < W*, (ii) DWL0 < T C < W*, and (iii)DWL0 < W* < T C. In your answer, explain what Q occurs under each choice (NL vs. B), what net welfare is under each case, and which choice is socially optimal.

(e) Let Ppc be the amount consumers and producers together pay victims to move to Q, when a ban is imposed and it is possible for such a transaction to occur, i.e., W*+TEC* TC > Ppc> TEC*, and let Pv be the amount victims pay to consumers and producers together to move to Q , when the not-liable choice is made and it is possible for such a transaction to occur., so that DWL0 + TPB0 - TC > Pv >TPB0. For each of the three cases regarding transaction costs from part (d), show that victims always prefer the ban while consumers and producers always prefer the not-liable case for any possible equilibrium Pv and Ppc values.

answer E only