Chapter 75, Problem 2FRQ

To determine

The correctly labeled graph that shows the quantity of water bottles purchased, marginal external cost, socially optimal quantity of water bottles, and the size of a Pigouvian tax that could be used to achieve the socially optimal quantity of water bottles.

Explanation of Solution

The graph for the quantity of plastic water bottles:

The vertical axis of the graph represents the marginal social cost and price of plastic water bottles and horizontal axis shows the quantity of plastic water bottles. The supply curve which is equal to the marginal social cost curve indicates an upward slope and the demand curve is downward sloping.

The area under the market price and optimum quantity shows the Pigouvian tax which can be used to achieve the optimal quantity of water bottles and the marginal external cost is between the supply curve and marginal social cost curve.

The market quantity of plastic water bottles is found at the point where demand and supply curves intersect which is denoted by QMKT.

And, the socially optimal quantity of plastic water bottles in the market is at the point of QOPT where demand curve and marginal social cost curve intersect and this quantity is shown on the horizontal axis.

Economics Concept Introduction

Introduction: Externality problems such as pollution refers to the fundamental economic policy problems while firms do not internalize the indirect costs or indirect benefits from any of their economic transactions in the market. The quantity where all the costs and benefits are accounted is called socially optimal quantity.