Problem set 2

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Equilibrium is a point a state of balance between demand and supply forces in the market.

Actually in instances where the equilibrium quantity is greater than the socially optimal quantity then the production of any good is deemed to have a negative externality which in this scenario is pollution.

Since we are posed with both private demand and supply functions we can actually determine the private market equilibrium.

For a private equilibrium: Demand=Marginal Damage

P^D=M^D

200-2Q=40+Q

160=3Q

Q=53 units, and Price is $93

For a socially market equilibrium,

P^D=P^S

200-2Q=20+4Q

180=6Q

Q=30 units and P=$14

Clearly from the above explanation, it can be noted that the Private equilibrium is quite higher than the socially optimal equilibrium. This therefore underscores the existence of a negative externality. This can be illustrated graphically as shown below

Pigouvian tax.

To control the pollution the government can employ a level of tax per every unit of pollution caused. This is called Pigouvian tax

The ideal tax could be (93-30) which is $63