ECON 431 Midterm: ECON 431 Cal Poly SLO Midterm 2007
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Question 1a. (10 points) demonstrate on a diagram that the deadweight loss from a negative production externality is larger under competition than under monopoly for sufficiently damaging pollutants. Carefully label the axes and all relevant variables. Suppose two firms pollute a common water medium, and the water medium is well-mixed so that the damage from water pollution does not depend on the identity of the polluter. Firm 1 receives total benefit b1(x1) from polluting and firm 2 receives total benefit b2(x2) from polluting and these benefits differ; i. e. , b1(x) b2(x) for any (common) pollution level x. Pollution creates external costs in the economy and marginal external cost is increasing in the pollution level. Draw a diagram that shows the socially optimal level of pollution to be allocated between the two firms and the efficiency gain from a transferable permit policy in the case of an equal allocation of permits to each firm. Label the equilibrium permit price on your diagram.
