Question - In a small town, there is an extremely talented baker. In a competitive market with other bakers, he faces a private marginal benefit (demand) curve of 200-Q. The marginal cost curve for producing the bread is MC = 50 + Q.
When this baker bakes, he fills the town with the wonderful smells of delicious pastries, which all residents enjoy. The marginal benefit that occurs to the town can be described by MB = 10 + 1/3Q.
This question describes an externality. What type of externality?
In the absence of any kind of "solution" what Q does the baker choose to produce?
What is the socially optimal level of production?
Draw the curves and plot the two levels of production to show the differences between the socially optimal and privately optimal levels of production.
If there was a private solution to the problem presented by this externality, what would it look like (use your imagination)? What is the name of this type of solution, and do you think it would be feasible in this instance?
If the private solution was not feasible, what would be the public-sector remedy? Be specific.