Negative externalities
Assume a market for fertilizers, and let D denote the demand of fertilizers while S their supply. The inverse demand is p = 10 - q. and the supply is MC = q. The marginal damage created by runoff water being exposed to fertilizers is MEC = q/2
The use of fertilizers is creating an externality and the government wishes to intervene in the market.
a. Use a figure to depict the competitive outcome. Derive the competitive equilibrium outcome.
b. Use a second figure to explain the negative externality attributed to the use of fertilizers. The use of fertilizers improves yield, but it also damages the underground aquifer.
c. What is the Pigovian Tax? Use a figure to explain. Can it be used to correct for the externality. Derive the Pigovian tax and characterize the social optimum solution.
d. Can a standard achieve the social optimum? What about a quota? Explain using a figure.