Suppose that the marginal private cost of paper production is MP C(Q) = 3+9Q where Q is the industry output. Suppose also that the marginal private benefit of paper products is MP B(Q) = 193 10Q. The paper production process is smelly and causes water pollution - a negative externality. Suppose that this causes a constant amount of external harm E = $38 for each unit of paper produced.

1. What level of paper production would there be in an unregulated market (call this Qm1)? What would be the price pm1? What is the efficient quantity Q ? Draw a diagram of the paper market, showing these quantities.

2. Suppose the government introduces a subsidy for reductions in paper production, compared to the unregulated market quantity Qm. For each unit of paper not produced, relative to Qm, firms are paid the subsidy s = $38. How much paper is produced?

3. Show the cost of the subsidy to the government on your diagram. 4. Is society better or worse off after the subsidy (according to the Pareto criteria)?