Suppose that a Hydrocarbon Cracking Operation, Inc. is a monopoly and has the demand, marginal revenue, and marginal cost functions as shown in the graph below.
a. What price and output combination will the monopoly select?
b. Suppose the production of oil generates water pollution in a nearby river that costs a constant $10 per barrel of oil produced. What is the size of the negative externality? If the monopolist included the cost of the negative externality in its marginal costs, how would the marginal cost curve shift? Copy the graph and then draw in the social cost curve that includes the cost of the negative externality in the monopoly’s marginal costs.
c. If a tax equal to the negative externality is imposed on each barrel of oil produced, what price will the monopolist charge and how much oil will be produced? Will this policy improve the quality of water in the river? How?