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The efficient market (socially desirable) equilibrium levels of price and output. What action might the government take in each case to ensure that the efficient level of output is restored?a) An industry emits carbon gas into the atmosphere.

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Introduction

Question 1 Using figure 10.1, p.199 of your prescribed text as a starting point, explain the impact of the following events on the efficient market (socially desirable) equilibrium levels of price and output. What action might the government take in each case to ensure that the efficient level of output is restored? a) An industry emits carbon gas into the atmosphere. As shown in the figure, at the normal market price (Pp) when the supply and demand for the product is balanced or at equilibrium (Ep), the quantity produced or consumed is at the level of Qmarket. Thus, Qmarket quantity maximises the total value to buyers minus the total private costs to the industry. But when the industry emits carbon gas in to the atmosphere, it causes air pollution for the people who breathe the air, thus producing a negative externality. An externality is the impact of one person's actions on the wellbeing of a bystander and an adverse impact causes a negative externality (Gans, King, Mankiw, 2003, p. 198). Because of this externality, the cost to society for producing the good is larger than the cost to the industrial producers. For each quantity produced, At any given quantity, this social cost curve (Ss) is above the supply curve Sp, the difference between the two curves showing the cost of the externality. ...read more.

Middle

The government can correct the market failure by internalising this externality by means of a tax on tobacco. As seen in Figure 3, when the government imposes a tax, it will increase the price of tobacco to consumers and this will lessen the demand quantity(to Q), bringing the demand quantity closer to socially desirable QOptimum level. If the tax is optimal it will equal the externality cost, shifting the demand curve down, thus allocating resources to balance efficiently at Es. Workers Output MP AP FC ($) VC ($) TC ($) MC ($) AVC($) AFC ($) ATC ($) 0 0 0 - 200 50 x 0= 0 200+0= 200 - - - - 1 5 (5-0)/(1-0)= 5 5/1= 5 200 50 x 1= 50 200+50= 250 (250-200)/(5-0)= 10 50/5= 10 200/5= 40 250/5= 50 2 15 (15-5)/(2-1)= 10 15/2= 7.5 200 50 x 2= 100 200+100= 300 (300-250)/(15-5)= 5 100/15= 6.67 200/15= 13.33 300/15= 20 3 28 (28-15)/(3-2)= 13 28/3= 9.33 200 50 x 3= 150 200+150= 350 (350-300)/(28-15)= 3.85 150/28= 5.36 200/28= 7.14 350/28= 12.5 4 40 (40-28)/(4-3)= 12 40/4= 10 200 50 x 4= 200 200+200= 400 (400-350)/(40-28)= 4.17 200/40= 5 200/40= 5 400/40= 10 5 48 (48-40)/(5-4)= 8 48/5= 9.6 200 50 x 5= 250 200+250= 450 (450-400)/(48-40)= 6.25 250/48= 5.21 200/48= 4.17 450/48= 9.38 6 55 (55-48)/(6-5)= 7 55/6= 9.17 200 50 x 6= 300 200+300= 500 (500-450)/(55-48)= 7.14 300/55= 5.45 200/55= 3.64 ...read more.

Conclusion

Thus the firm is shifting towards achieving economies of scale, which is reached when the third worker is employed. After this point, as the firm starts to experience decreasing marginal product, and marginal costs rise increasing inefficiency, hence diseconomies of scale set in. The Average Variable Cost(AVC) curve changes as the firm alters the quantity of output produced. When Marginal cost is less than AVC, the AVC decreases while when Marginal Cost is higher than AVC, the AVC increases. This increasing and diminishing marginal cost makes the AVC curve U-shaped. The average fixed costs are average of costs that don't vary with the quantity of output produced. The firms'AFC curve has a steady decline as output rises, because the fixed cost is getting spread over a larger number of units. The Average Total Cost curve represents the cost of a typical unit; the total of AVC and AFC. From the graph, when output is increasing, a steady decline of ATC is visible with a small increase nearer to the end resulting in a slight U-shape curve. This is because ATC curve is influenced by shapes of both AFC and AVC curves. Initially at low levels of output the ATC is high because fixed costs are spread only over a small number of outputs. Then ATC declines as output increases until output is 55 units per day, when ATC is $9.09 per unit of furniture. When the firm produces more than 55 units, ATC starts rising again, because of the rise in AVC. ...read more.

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