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1. The California Department of Agriculture (CDFA) has conducted a contingent valuation study and determined that vineyards provide an external benefit in the form of environmental amenities (i.e., attractive landscape for tourists) worth $50 million (on average, about $100 per acre of vines) per year. Suppose you are employed to advise the government on policy. What policy would you recommend that the government should adopt with the aim of maximizing total economic welfare in California. Should we subsidize wine production? Please make your answer brief, but indicate specifically how the policy would be implemented.
In addition, please discuss briefly any possible side effects of your recommended policy.
Answer: Because of the positive external benefit, marginal social cost should be lower than marginal producer cost, which means a positive DWL for society. Based on this fact, I will suggest to subsidize wine production so that their marginal producer cost line could shift to right until the level of marginal social cost. The size of subsidy should make sure an increasing producer surplus. Consumer surplus will definitely increase due to a lower wine price. DWL for society will decrease. And government will spend some money for subsidy....
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