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Don't understand this graph (AS Micro)

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    Hi, I don't really understand why setting a tax to t* or prohibiting emissions beyond e* does anything to ensure there there is allocative efficiency. Attachment 521017521019
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    Allocative efficiency is where marginal social cost = marginal social benefit. With a good that produces emissions the marginal social cost exceeds the marginal social benefit so government intervention is required to reduce production. This can be done through taxing the product which shifts supply inwards by raising firms costs of production and increasing the price so less is demanded. Or else, it can be done by regulation forcing firms to cut production to reduce emissions. Whichever method is used the aim is to reduce production so that marginal social cost = marginal social benefit and allocative efficiency is achieved.
    Mark Potts
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Updated: April 10, 2016
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