Suppose the Canada market for cannabis products is perfectly competitive, and the production of cannabis results in an externality in the form of water pollution from agricultural runoff. This market can be characterized by the following equations (where Q is expressed in thousands of pounds and P is in CA$ per pound):
Inverse Market Supply:Ps = 1000 + 2Q
Inverse Market Demand:P. = 3000 — 3Q
Marginal External Cost: MEC = 200 + Q
a. Graph and solve for the market equilibrium price and quantity of cannabis. (4 points) b. Graph and solve for the socially optimal price and quantity of cannabis (i.e., the efficient solution). (4 points)
c. What are the social welfare gains from internalizing the externality (i.e., what is the deadweight loss caused by the externality)? Indicate the area on the graph and solve for the actual number. (4 points)
d. Policymakers in Canada want to correct the market failure caused by the externality using an optimal (Pigouvian) tax. What size of tax (in CAS per pound) should they impose? (4 points)
e. What is the new market equilibrium price that buyers pay (including the tax), and what is the price that sellers receive after the tax is paid to the government? (4 points)
f Calculate the consumer surplus, producer surplus. and total government tax revenue alter the tax is imposed. (5 points)
g. Explain why externalities are often cited by policymakers as justification for imposing taxes. Why is taxing goods that are associated with negative externalities a good thing for society? (5 points)
