Question

Consider the production of paper in Strelsau. Suppose that the supply of paper is upward-sloping and the demand for paper is downward-sloping. Suppose that the production of paper causes a negative externality of $0.50 per ream (because the smell of the paper production process in this town is both strong and horrific), and the conditions outlined by the Coase theorem do not hold. By how much does the optimal price per ream of paper differ from the market price per ream of paper?

Answer 1

Answer: The optimal price is higher than market price by less than $0.50.

Explanation:

Since, it was given that Coase theorem doesn't hold in this situation, hence, the social marginal cost is greater than the private marginal cost by $0.50. The social marginal cost curve lies towards the left of demand curve.

Since the demand and supply curve are not perfectly elastic or inelastic, so the optimal equilibrium occurs at a point (price) which is greater than the prevailing market price, but the difference in the price is less than $0.50.

Therefore, the optimal price is higher than market price by less than $0.50.