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In Figure It Out 17.1, you analyzed what happens when competitive paper producers create a negative externality. Then, you compared the market outcome to the socially ideal outcome.

• The industry short-run supply curve (or marginal cost curve) in Figure It Out 17.1 is *P = MC = 2Q ^{S}*, where Q

• The inverse demand for notebook paper is *P = 40 – 8Q ^{D}*

• In their production processes, paper manufacturers have been dumping waste in nearby streams. The external marginal cost is estimated to be $0.50 for each ream produced.

• The equilibrium price and quantity in the market are *$8* and 4 million reams of paper, respectively.

• The socially optimal price and quantity are *$8.40* and 3.95 million reams.

**a. Suppose government places a $0.50 tax on each ream of paper sold. What price would buyers pay and what price would sellers receive (net of the tax)?**

**
Buyers would pay $ **
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** Sellers would receive $ **
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Remember that when a tax is imposed, the buyers’ price (*P*^{B}) and the sellers’ price (P^{S}) differ by the amount of the tax. Rewrite the demand curve as *Q*^{D} = 5 – .125(P^{S} + 0.50), and equate to the supply curve, *Q*^{S} = .5P^{S}. Set *Q*^{D} = Q^{S} and solve to find *P*^{S} = $7.90. Add back the *$0.50* tax to find *P*^{B} = $8.40, identical to the socially optimal price. For further review see section “Fixing Externalities”.

** b. How many reams of paper would be sold? Please round your answer to two decimal places. **
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** million reams would be sold.**

To find the quantity of paper that would be sold, either plug the sellers’ price into the supply curve, or plug the buyers’ price into the demand curve (both will give the same answer). On the supply side of the market, *Q*^{S} = 0.5P^{S}, and *P*^{S} = $7.90. So *Q = 3.95*, identical to the socially optimal quantity. For further review see section “Fixing Externalities”.