Assume the existence of two substitute goods, R and T. There is a distortion in each market as there is a price ceiling for good T beneath the equilibrium price and a negative externality in market R (An externality is represented by the gap between the private marginal cost for the firm (MCp) and the social marginal cost (MCs) curve at each level of output).

a) On separate diagrams please illustrate the price ceiling for good T and the negative externality for good R. Assume regular downward sloping demand curves and upward sloping supply curves

b) What is the welfare loss associated with each distortion in each market? Why?

c)Suppose that the government can only impact the market for R, through the use of economic instruments in the market for T. Which instrument would you use in the market for T, to eliminate the distortion in R? Why?

d) From a welfare perspective does it make sense to use an economic instrument in T to eliminate the distortion in R? Why?