Questions 5, 6, and 7 consider the perfectly competitive market for Honey.Honey is produced by beekeepers, each of which have traditional U-shaped average cost curves.There are many firms in the honey industry, each producing a homogeneous product: honey.Market demand for honey can be characterized as a downward sloping linear function.

For this question, ignore any externalities that might be associated with the production of honey.

• Graphically indicate the demand (D₀) and Supply (S₀) and the equilibrium in the market for honey.Show the equilibrium price and quantity, Q₀and P₀.Indicate on your graph the areas of consumer surplus and producer surplus.
• What is the output level the Benevolent Dictator would like to see in this market?

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Now suppose that scientists have discovered that the production of honey has a very significantpositive externality.The main input into honey production, honey bees, are most effective when there are orchards nearby. The bees gather nectar from the orchards and simultaneously pollinate the orchard.This pollination is very valuable to the orchard.

However, honey firms (beekeepers) are not compensated for this positive impact on orchards.This positive externality means that the true marginal social value of producing honey is different than the marginal private value of the consumption of honey.Indeed, the Marginal Social Value for the industry would be the sum of the marginal private value (the demand curve)plusthe positive impact each unit of honey production has on orchards.That is, in the eyes of the benevolent dictator, the production of honey has Marginal Social Value per unit higher than the marginal private value (the demand curve).

• Construct another graph.Show the original demand and supply (labeled correctly asD₀andS₀) and equilibrium price (P₀) and quantity (Q₀).
• Now add another curve that reflects the Marginal Social Value given the existence of the positive externality, and label it appropriately.
• What, if anything, happens to price and quantity of honey established in the marketplace, given the presence of this positive externality?
• What is the outputQ_SO6the Benevolent Dictator would choose (where SO6 stands for Socially Optimal output here in question 6, which may or may not be different than the socially optimal output you found in question 5)?
• Indicate graphically and explain in a narrative the area of deadweight loss (DWL), if any, given the existence of this positive externality. What does deadweight loss mean in this context?

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Given the presence of positive externality and considering ONLY the issue of maximizing the size of Social Gain (the sum of consumer surplus and producer surplus:

• Should the government intervene here or leave the market alone?Why?
• If you suggest intervention, what type of policy would be best?Why?