"Let the marginal benefits and marginal costs of gasoline consumption (where Q=gallons) be:
MB (Q) = 5 - 0.2Q
MC (Q) = 0.03Q
a) Solve for the equilibrium price and quantity assuming the market is perfectly competitive.
Now you learn that each gallon of gasoline burned generates additional social costs from the pollution of NOX, SOX, PM, and CO2. The marginal external costs are given by: MCexternal (Q) = 0.1 + 0.5Q
b) Solve for the socially efficient quantity and price per gallon of gasoline.
c) What is the efficient per gallon tax on gasoline that will generate the answer to part (b)?
d) How much of the tax is paid by consumers? How much by producers? Why?
e) What is the welfare gain from internalizing the pollution externality?
f) If instead of per gallon gas tax, the government required an increase in the fuel efficiency of new cars sold would you expect to fully internalize the pollution externality? Why or why not?