A state in the northwestern United States faces a number of problems concerning the production of its paper products. The wood pulp industry (from which paper is made) is a monopoly that generates a significant amount of pollution. As the state’s secretary of commerce, you have hired three analysts to help you think through several government policy alternatives. The demand for wood pulp is given by: P = 500 - 10Q, where Q is measured in thousands of units. The long-run cost of production exhibits constant returns to scale: LAC = LMC = 150. Producing a unit of wood pulp generates one unit of pollution. The marginal external cost is estimated to be 100 per extra unit of pollution.
a. Analyst A advises no government intervention at all. In this case, what quantity and price will prevail in the (monopolized) industry?
b. Analyst B is mainly worried about the monopolization of the industry, and, therefore, recommends that you promote competition through regulation and antitrust policy. What quantity of pulp would a perfectly competitive industry produce?
c. Analyst C is worried about the pollution externality and, therefore, recommends a tax of 100 per unit of pulp output (on the currently monopolized industry). What quantity of pulp will the monopolized industry produce under the tax?
d. Which of the analysts’ recommendations would you support? Do you have a better policy? Explain. (Identify the socially efficient level of pulp production to help clarify your answer.)