Firms in an industry produce an aggregate output Q, yielding marginal social benefits according to the marginal benefit schedule MB(Q), which is downward-sloping. (Think of this as the demand curve facing the industry.) Assume that the marginal private cost (‘MPC’) schedule of firms is positive and upward-sloping for all output levels Q ≥ 0.
In the process of production, firms pollute the environment, where these pollution damages are captured by the industry marginal damage (‘MD’) schedule. Consider a specific instance in which the industry’s MPC schedule is given by:
MPC(Q) = 4 + ½ Q.
Further, the industry MD schedule is given by:
MD(Q) = Q,
and the benefit schedule is given by:
MB(Q) = 9 – Q.
a) Solve for the aggregate output level, Q1, that firms would choose in the absence of regulation. (2 points)
b) Solve for the socially efficient output level, Q*, numerically. (2 points)
c) How could you demonstrate, intuitively, that aggregate output Q1 was socially inefficient? (3 points)