Amityville has a competitive chocolate industry with the (inverse) supply curve P = 440 + Q. While the (inverse) market demand for chocolate is pd = 1200 - Q, there are external benefits that the citizens of Amityville derive from having a chocolate odor wafting through town. The marginal external benefit schedule is MEB = 60 - 0.05Q. 1. What is the socially optimal amount of chocolate production in Amityville? 2. Since there is a positive externality, the level of chocolate production in a competitive market will be too low. If the government of Amityville used a subsidy of $S per unit to encourage the optimal amount of chocolate production, what level should that subsidy be? Hint: the principle is the same as finding the optimal tax when there is a negative externality, the subsidy should be related to the marginal external benefit just like the tax is related to the marginal external cost.

Amityville has a competitive chocolate industry with the (inverse) supply curve P = 440 + Q. While the (inverse) market demand for chocolate is pd = 1200 - Q, there are external benefits that the citizens of Amityville derive from having a chocolate odor wafting through town. The marginal external benefit schedule is MEB = 60 - 0.05Q. 1. What is the socially optimal amount of chocolate production in Amityville? 2. Since there is a positive externality, the level of chocolate production in a competitive market will be too low. If the government of Amityville used a subsidy of $S per unit to encourage the optimal amount of chocolate production, what level should that subsidy be? Hint: the principle is the same as finding the optimal tax when there is a negative externality, the subsidy should be related to the marginal external benefit just like the tax is related to the marginal external cost.

Economics: Private and Public Choice (MindTap Course List)

16th Edition

ISBN:9781305506725

Author:James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. Macpherson

Publisher:James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. Macpherson

Chapter5: Difficult Cases For The Market And The Role Of Government

Section: Chapter Questions

Problem 10CQ

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