Answer to Question #277022 in Microeconomics for Claudia

Question

Assume that a competitive firm sells it’s output for a price of 16 dollars per unit and

producing q units of output costs the firm 1/3 q3 dollars. The firm’s production process

pollutes a nearby river and total environmental damage caused is e = 3q − a where

a is the amount of pollution abatement effort. The firm’s cost of abating a units of

pollution is 1/3a3.

(a) Find the firm’s profit maximizing output quantity and the resulting amount of

environmental damage in the absence of any regulation.

(b) If the firm must pay a tax of $7 per unit of output produced, find the new profit

maximizing output quantity and amount of environmental damage.

(c) Assume there is public backlash to the tax on output, so the government needs

to determine what subsidy per-unit of abatement effort would replace the tax

and yield the same environmental damage. What subsidy on abatement effort

should the government set?

Answer 1

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