Externalities. Consider the example of the perfectly competitive steel firm from class. The firm takes the market price p = $35 (per unit of steel) as given and chooses quantity q (units of steel) to maximize its profits. The firm has increasing (private) marginal costs given by the equation MC = 5q. The residents in a nearby town suffer damages from the firm’s emissions of sulfur dioxide. A researcher at a local university has estimated their marginal damages to be given by the equation MD = 2q.

(d) Design a (“Pigouvian”) tax that would correct this externality and lead the steel firm to produce the socially efficient level of steel. In a new graph, show the effect of the tax. (The tax should be a number or an equation.)