Hi there, can you please help with the below question, with diagrams please!
Suppose there is a consumption externality for drug use. Do a standard welfare analysis and propose a Pigovian tax.
Consumption externality for drug use is a negative externality where there exists external disbenefits to people who are not involved in the production and consumption of drugs.
This has marginal social benefit less than marginal private benefit with marginal social cost equal to marginal private cost.
Market equilibrium quantity is produced at PMB = SMC where quantity of drugs consumed is qm at a price of pm.
Socially efficient quantity is consumed at SMB= SMC where quantity traded is q* at a price of p*.
This results in deadweight loss represented by the shaded area in the graph.
The problem of externality can be solved by imposing pigovian tax equal to per unit external cost. This will decrease marginal private benefit to marginal social benefit and will result in socially efficient quantity produced.
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