Look back at Question numer two of Problem Set threeb (remember we have an answer key posted as well on the assignment page) and take a look at our analysis of a $6 excise tax. In that case, we were analyzing the tax while assuming that the free market was efficient. Now, in the context of an externality, imagine that the tax is a Pigouvian tax. e) What is the policy goal of the Pigouvian tax? f) What is the impact on the quantity of widgets sold? Does the policy achieve its goal? g) What is the impact of the tax on total surplus / deadweight loss? Is the outcome efficient? (No need to calculate here, we are basing this off of theory.) h) One of the issues with Pigouvian taxes is that it can be difficult to estimate the tax level. Imagine the government inadvertently sets the tax too high, at $7 rather than $6. What would you predict would happen to the market? (No need to calculate anything - base this off of what we know about excise taxes.) Now imagine that the government sets the tax too high, at $5 per widget. What would we predict would happen?

3) Unit 3: Externality 8; Pigouvian Tax (10 points] Let's return to our market for Widgets that we examined in Problem Set 3. You'll recall that we looked at a welfare analysis of three policies: [1] a price ceiling of $6, [2) an excise tax of $6 on widgets, and [3) opening up to international trade when the world price is $6 per widget. This time, let's imagine that there is an SUPPIY and Demand for Widgets external cost associated with the production of Pr i c o widgets, and that external cost is estimated by economists to be $6 per widget. 322 $20 a. 0n the graph, draw and label the social $18 cost curve that reects the externality. S 1 E: S 31 r1 b. How many widgets are provided by 312 the private market [without . . $1 0 intervention]? 38 36 34 What would be the socially optimal 32 0 quantity of widgets produced? 0 m r: 40 63 8-3 100 120 MO Quantity Without intervention in this market, what is the deadweight loss that arises as a result of the externality? Clearly label the area on the graph and calculate the dollar value. d. What are two market-based policy options that we could use to address the externality? Be specic about the amounts of each intervention