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Negative Production Externality: A saw mill dumps one gallon of effluent into a lake for every 1000 pounds of lumber it produces. Each gallon of effluent dumped into the lake causes environmental damage equal to $150. Assume that demand is perfectly elastic and that the price of a 1000-pound pallet of lumber is $550. Marginal costs of production per pallet of lumber to the firm are MC = 50 + 0.1q.
a. What are the privately optimal (market) and socially optimal production levels of lumber and the amount that lumber production must be reduced to reach the socially optimal level?
b. Calculate the amount of social loss that society would bear as a result of ignoring this externality.
c. What would A.C. Pigou propose to resolve the problem? Be specific
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