In problem, suppose that instead of imposing a tariff on Japanese cars, the government offers a $1,000 subsidy to each American who buys an American car.

Suppose that Japanese cars and American cars are identical from the viewpoint of their owners, but that Japanese cars cause harmful pollution while American cars do not. Each American owner of a Japanese car imposes $1,000 worth of pollution costs on his neighbors. Suppose that the U.S. supply and demand curves for cars cross at a price of $10,000, but Americans can buy as many cars as they want to from Japan at $7,000 apiece.

(To prevent abuse of the subsidy, U.S. consumers are not allowed to resell their cars abroad.) What price do U.S. producers receive for cars? What price do U.S. consumers pay? Does the subsidy increase social gain? By how much?