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QUESTION
A town is trying to promote local farming but at the same time needs to collect taxes for public goods and other purposes. Consider two neighboring...
- A town is trying to promote local farming but at the same time needs to collect taxes for public goods and other purposes. Consider two neighboring farmers: Bob's bees is a honey producer and his neighbor is John's Jams. The more honey Bob produces, the more fruit Jon is able to produce to make jam.
- Graph hypothetical supply and demand curves for Bob's honey and include the externality in your graph. What type of externality is it (i.e, is it positive or negative, production or consumption)? Is Bob likely to be producing the efficient level of honey? Identify any dead weight loss due to the externality.
- Suppose the local government imposes a tax on Bob's honey. Will the additional deadweight loss created by the tax be greater, smaller or the same as it would be in the case where a tax is applied but there is no underlying externality. Explain and illustrate on your graph.
- How would your answer change to part B if the production externality were negative? (Perhaps because Bob's bees sting John's jam-makers and John doesn't make jam with fruit that needs to be pollinated.)
