Y7

Suppose Demand is defined as P=20-q, Marginal Cost (Private) = q, and Marginal Cost (public) = q+5. In this case there is a $5 external marginal cost.

a) Calculate the socially optimal output.

b) Under perfect competition, what is the DWL due to the externality?

c) Under perfect competition, what is the optimal Pigouvian tax?

d) Now assume there is a monopolist. What level of output would be chosen by the monopolist in this market?

e) What would be the optimal tax on a monopolist (to eliminate overall DWL)? How does this tax compare to your answer to part c?