Assume that the market supply in a competitive industry is p = Q. Demand is p = 100 - Q. Production creates pollution with a social cost of $1 per unit of output. In response to environmentalists, the government creates a tax of $2 per unit

Draw a well-labeled graph and:

a) Determine the equilibrium quantity, price and total welfare without government intervention.

b) Determine the socially optimal output level. What is the resultant total welfare now? Find its value and also label this area on your graph.

c) When the government imposes the tax, what is the value of producer surplus (also label the area on your graph)? Label the deadweight loss created by the tax on your graph.

d) What amount does the government collect in tax revenue? What is the externality cost?