Supposse the (external) damage done by pollution is known to be MD=300+5q, and the (private) cost and benefit are given by MC=100+2q and MB=D-2q, where D is not known.
a) If d=1000, what would be the optimal quantity? What tax would be necessary in order for that to be the equilibruim quantity?
b) Suppose that, based on the resultfrom part (a), a cap-and-trade system is imposed to allow the optimual quantity of polution to be produced. If D=900, what would be the deadweight loss associated with having the wrong quantity?
c) Suppose that, based on the result from part (a), a tax is imposed to allow the optimal quantity of polution to be produced. If D=900, what would be the deadweight loss associated with the wrong tax level?
d) If D is not exactly known, which is likely to give better results, acap-and-trade system or a tax? What would be the answer to this question if MD were 300+3Q instead of 300+5q
e) Can the social optimum be achieved using a tax on pollution?