The supply of paper is described by Qs=5000P where Qs is tons supplied per year and P is the price per ton. The demand is described by Qd=400,000-1000P where Qd is tons demanded per year. Because of the pollution associated with paper production, marginal external costs of $20 are associated with each ton of paper. a. Assuming that paper is sold in a competitive market with no regulation, what is the market price and quantity produced? b. Show and explain how can a corrective tax achieve efficiency? c. Assume a tax of $40 per ton is proposed. Would the proposed tax improve market efficiency (reduce deadweight loss)? Show and explain.

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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.