Suppose that a new company specializing in quick (under 5 minutes) automobile oil-changes has opened a number of franchised chains in D.C. The company charges $30 per oil change and currently sells 10,000 oil changes per year. From basic market analysis and observation, it appears that the marginal cost of the firm is $30 per oil change and is independent of the number of oil changes sold.
Unfortunately, the company uses a process that results in considerable leakage of hydrocarbon emissions into the air. No federal regulations prevent these emissions, but the D.C. government can impose a tax on oil changes that use this polluting process.
An analysis presented by an expert panel indicates that the social cost of the emissions is $10 per oil change. Economists have estimated that the price elasticity of demand for the quick oil changes is -0.5 at the current price and quantity (assuming a linear demand schedule).
a.) In a correctly labeled graph, illustrate the market for oil changes in the county given the information provided above. (4 points)
b.) Imagine that the county imposes a $10 tax per oil change on the polluting company. What are the annual net benefits of this tax? Why? (4 points)
c.) Imagine that, as a result of the tax, 50 percent of those who no longer purchase oil changes from the chain get oil changes at garages using traditional (30 minute) processes that emit no pollutants. Assume that the extra business does not affect the price these garages charge. The other 50 percent of former customers, however, do their own oil changes. Of the do-it-yourselfers, 60 percent follow procedures that result in no pollutants, while 40 percent dump oil illegally into storm sewers at a social cost of $20 per oil change. Do net benefits of the tax change? If so, why? (5 points)