The manufacture of trucks produces pollution of various kinds; for the purposes of this example, let's call it all "glop." Producing a truck creates one unit of glop, and glop has a cost to society of $3,000. Imagine that the supply of trucks is competitive, and market supply and demand are given by the following data:
Price (thousand $) 19 20 21 22 23 24 25 Quantity supplied 480 540 600 660 720 780 840 Quantity demanded 660 630 600 570 540 510 480
Graph the supply curve for the industry and the demand curve. What are equilibrium price and output? Now graph the social marginal cost curve. If the social cost of glop were taken into account, what would be the new equilibrium price and output? If the government is concerned about the pollution emitted by truck plants, explain how it might deal with the externality through fines or taxes and through subsidies. Illustrate the effects of taxes and subsidies by drawing the appropriate supply and demand graphs. (Don't bother worrying about the exact units.) Why are economists likely to prefer fines to subsidies?