Widget production is a constant cost perfectly competitive industry. Widget production creates harmful smoke that causes health problems for nearby residents - assume that every widget produced creates the same external cost for them.

A. Use a graph to illustrate that a perfectly competitive market will result in overproduction of widgets for the long run case. Show the amount of social losses on your graph.

B. The government introduces a per unit tax equal to the marginal external cost of producing one widget. In the short run, will this policy eliminate the social losses from the externality (assuming that, in the short run, the Law of supply holds for widgets)? Use a graph to indicate the buyers' price of widgets, sellers' price of widgets and the quantity of widgets sold in the new short-run equilibrium.

C. What will happen to the equilibrium price and industry output, as the industry adjusts to its long run equilibrium? Use your graph from (B) to illustrate your answer. Who pays the burden of the tax in the long run?