The following graph provides a stylised representation of the effects of the policy proposed by the government to correct for the externality (in the graph, S2 is the supply curve after the policy is implemented). 1.  If the policy is implemented, what is the price-quantity combination determined by the market? 2. If the policy is implemented, what is the price that buyers pay? 3. If the policy is implemented, what is the deadweight loss generated by the externality?

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Market Failure Analysis

To understand Market failure, we need to first understand welfare economics. An Italian economist, Vilfredo Pareto stated that allocation of resources in an efficient manner such that an economic change, which harms no one and makes someone better off, indicates an increase in social welfare. It is also called Pareto Optimality, where resources cannot further be reallocated without harming one. This does not apply to those economic changes, which harm some and benefit others. social welfare increases if the utility of any of its members' increases and none decrease in the economy.