Refer to the above supply and demand graph.In the graph,point A is the current equilibrium level of output of this product and point B is the optimal level of output from society's perspective.S is the supply curve without a tax and S_t is the supply curve with a tax.One solution to this externality problem is to: A) give consumers a subsidy of the amount FG. B) give producers a subsidy of the amount AB. C) tax producers by the amount DE. D) tax consumers by the amount EF.

Question

Quizplus · Accepted Answer

To reach the optimal level of output from society's perspective, the quantity supplied needs to be reduced from Q* to Qb. This can be achieved by taxing the producers by the amount of DE, which will increase the cost of production and shift the supply curve upward from S to S_t. This will result in a higher price for the consumers and a decrease in quantity demanded, resulting in a movement along the demand curve from point A to point B. By reducing the quantity supplied, the negative externality can be minimized, and the optimal level of output can be achieved. Giving a subsidy to consumers or producers, or taxing consumers, will not reduce the negative externality in this case.

Refer to the Above Supply and Demand Graph