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Consider the standard demand and supply diagram with pollution (click on the thumbnail to the right for a bigger image). An unregulated market leads to equilibrium price and quantity determined at the intersection of the supply, or marginal private cost (MPC), curve and the demand curve: P1, Q1.

Consumers and producers enjoy the gains from this equilibrium. The consumer surplus is the difference between willingness to pay (height of the demand curve) and price: area a + b + c + d. You enjoy consumer surplus every time you buy something and get a "good deal."

The producer surplus is the difference between the revenue earned on each unit (P1) and its marginal cost of production: area f + g + h (note that f includes the tiny triangle below P1 and above the MSC curve). Producer surplus is equivalent to profit without the fixed cost (e.g., monthly lease payments that don't change with output).

Unfortunately, production of Q generates some harmful side (i.e., external) effects......

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Approximate Word Count: 522
Approximate Pages: 3 (250 words per double-spaced page)

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