Suppose Merck is developing new drugs that have positive externalities; the positive externality is a pharmaceutical technology we all benefit from. Let the supply curve for Merck’s production be P =Q/4, where Q is the number of units of drugs they’ve developed. For each unit, the value of the positive externality is $2.
Assume market demand for these drugs can be written as Q=14-2P.
a. What is Qp in this market?
b. What is the socially optimal level of drugs bought and sold?
c. What is the deadweight loss in the free market resulting from the externality?
d. What would be the level of the Pigovian subsidy that would eliminate the deadweight losses due to the externality?