Question: Suppose that the (external) damage done by pollution is known to be MD = 300 + 5Q, and the (private) cost and benefit are given

Suppose that 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 = D0 − 2Q, where D0 is not precisely known.
a. If D0 = 1,000, what would be the optimal quantity? What tax would be necessary in order for that to be the equilibrium quantity?
b. Suppose that, based on the result from part a, a cap-and-trade system is imposed to allow the optimal quantity of pollution to be produced. If D0 = 900, what would be the deadweight loss associated with having the wrong quantity?
c. Supposed that, based on the result from part a, a tax is imposed to allow the optimal quantity of pollution to be produced. If D0 = 900, what would be the deadweight loss associated with having the wrong tax level?
d. If D0 is not exactly known, which is likely to give better results, a cap-and-trade system or a tax? What would be the answer to this question if the marginal damage were 300 + 3Q instead of 300 + 5Q?

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a Setting MB MC MD 1000 2Q 100 2Q 300 5Q which can be rearranged to 600 9Q and solved to Q 2003 6667 ... View full answer

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