Suppose you work as research economist at the EPA. There are two firms that operate in a perfectly competitive market. This implies that each has the same marginal benefit curve, which in this case is horizontal at MB = $100. Each of the firms, however, has a different marginal private cost schedule: MPC1= 20+Q and MPC2=30+2Q Each firmâs production process creates externalities that are valued by society at $10 per unit output. a) Show that without government intervention, the firmsâ profit maximizing outputs are Q=80 for firm 1 and Q=35 for firm 2, and the market price is $100. b) Now calculate the socially optimal level of output for each firm. c) Your boss knows that the firms are currently producing too much output and simply decides that all firms should cut their output by 15%. Show that this is an inefficient solution to this externality problem.
Suppose you work as research economist at the EPA. There are two firms that operate in a perfectly competitive market. This implies that each has the same marginal benefit curve, which in this case is horizontal at MB = $100. Each of the firms, however, has a different marginal private cost schedule: MPC1= 20+Q and MPC2=30+2Q Each firmâs production process creates externalities that are valued by society at $10 per unit output. a) Show that without government intervention, the firmsâ profit maximizing outputs are Q=80 for firm 1 and Q=35 for firm 2, and the market price is $100. b) Now calculate the socially optimal level of output for each firm. c) Your boss knows that the firms are currently producing too much output and simply decides that all firms should cut their output by 15%. Show that this is an inefficient solution to this externality problem.
