Externalities. Consider the example of the perfectly competitive steel firm from class. The firm takes the market price p = $35 (per unit of steel) as given and chooses quantity q (units of steel) to maximize its profits. The firm has increasing (private) marginal costs given by the equation MC = 5q. The residents in a nearby town suffer damages from the firm’s emissions of sulfur dioxide. A researcher at a local university has estimated their marginal damages to be given by the equation MD = 2q.
(b) Determine the market level of steel production, qm, that arises if the firm simply chooses its steel output to maximize profits, ignoring damages to the villagers. Calculate the deadweight loss to society that results from the market level of output (relative to the efficient level).