ECONOMICS 0105
HOMEWORK #4

1. Suppose the paper market can be represented by the numbers in Table 1. Further suppose that producers of paper dump their wastes in nearby rivers and inflict an external cost of $4 per unit of paper on downstream users of river water.

                               Table 1

P Q^D Q^S(pvt) Q^S(soc)

      $15         0           240

      $14       20           220

      $13       40           200

      $12       60           180

      $11       80           160

      $10     100           140

       $9      120           120

       $8      140           100

       $7      160            80

       $6      180            60

       $5      200            40

       $4      220            20

       $3      240             0

a. Graph the demand curve and both supply curves, labeling all relevant equilibrium points with numbers from Table 1.

b. Indicate the area on the graph that corresponds to the welfare loss associated with the external cost.

c. If government imposes a pollution tax of $2 on the paper industry, show this effect on a supply-demand diagram and indicate whether this will solve the externality problem. Are their other more efficient methods of resolving externality questions? Explain.