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Consider a group of firms with supply curve Ps = 10 + Qs, where Qs is the quantity of the good produced. The demand for this good is given by Pd = 50 - Qd, where Qd is the quantity demanded. The firms produce pollution along with their good. The external marginal cost of this pollution is $10/unit.
A.) What are the equations for the private marginal costs and the social marginal costs associated with production of this good? When the firms decide how many units of their good to produce, do they pay attention to private marginal costs or social marginal costs? Explain.
B.) How many units of the good are produced in a competitive market equilibrium? What is the socially optimal quantity of the good? Show your work.
C.) What is the value of the economic surplus at the competitive market equilibrium quantity? What is the value of the economic surplus at the socially optimal quantity? Which one is larger, and why?
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