The accompanying diagram shows the U.S. market for automobiles. P0 is the world price of automobiles, Q0 is the quantity of American automobiles produced, and Q1 - Q0 is the quantity of automobiles imported. Consumers are indifferent between American and imported automobiles, but each imported automobile creates $100 of pollution costs.

(i) Calculate consumers' surplus, producers' surplus, the pollution damages, and social gain when no attempt is made to internalize the externality.

(ii) Suppose the government imposes a $100 tariff on imported automobiles. Calculate consumers' surplus, producers' surplus, tariff revenue, the pollution damages, and social gain in this situation. Did the tariff increase social gain? Did the tariff result in an efficient outcome? Explain.

(i) Consumers' surplus is area A + B + C + D + E + F + G. Producers' surplus is area I. Q1 - Q 0 automobiles create pollution damages, so area D + E + F + G + H measures the external costs of pollution from the imported automobiles. Combining these three areas shows that social gain is equal to area A + B + C + I - H.
(ii) The tariff raises the price of automobiles to P0 + $100, so consumers' surplus falls to area A + B and producers' surplus rises to area C + D + I. After the tariff is imposed, only Q1' - Q0' automobiles are imported, so area F represents the pollution damages. These external costs are exactly offset by the tariff revenue, which also equals area F. Social gain is thus equal to area A + B + C + D + I. The tariff increased social gain by area D + H (which equals area E + G, the usual deadweight loss under a tariff). This outcome is efficient as long as there is no alternative low-cost method of avoiding the pollution costs.