Use the following figure, which illustrates the market for...

Use the following figure, which illustrates the market for cotton, to work. Suppose that the cotton growers use a chemical to control insects and waste flows into the town's river. The marginal social cost of producing the cotton is double the marginal private cost. If no one owns the river and the town takes no action to control the waste, what is the quantity of cotton and the deadweight loss created?

Use the following figure, which illustrates the market for cotton, to work.
Suppose that the cotton growers use a chemical to control insects and waste flows into the town's river. The marginal social cost of producing the cotton is double the marginal private cost.
If no one owns the river and the town takes no action to control the waste, what is the quantity of cotton and the deadweight loss created?

Key Concepts

Deadweight Loss

Deadweight loss represents the loss of economic efficiency that can occur when the equilibrium outcome is not Pareto optimal, often due to market distortions like externalities. In the context of a negative externality, deadweight loss results because the market produces more than the socially optimal level of output, leading to a net loss in welfare as the unaccounted external costs exceed the benefits gained from the excess production.

Market Failure

Market failure refers to situations where the free market, on its own, fails to allocate resources efficiently, resulting in a loss of economic and social welfare. Negative externalities are a classic cause of market failure because the private decision-making process does not consider the full social cost, leading to overproduction and other inefficiencies that harm society.

Negative Externality

A negative externality occurs when a production or consumption activity imposes costs on third parties who are not directly involved in the transaction. In production, this often means that the costs to society (such as pollution or environmental degradation) exceed the costs borne by the producer, leading to market inefficiencies when these external costs are not reflected in market prices.

Marginal Private Cost vs. Marginal Social Cost

Marginal Private Cost refers to the cost incurred by a producer for producing an additional unit of a good, while Marginal Social Cost includes both the private cost and any external costs imposed on society. When there is a negative externality, the marginal social cost is higher than the marginal private cost, indicating that the true cost of production is underestimated by the market.

Transcript

00:01 Here we are asked to calculate a deadweight loss in a situation where there is a negative externality.

00:08 I've gone ahead and drawn and labeled these axes with units, and we're going to draw our supply and demand curves one point at a time, and this will be clear why we're doing this in a moment.

00:23 For our demand curve, we're told that at a price of 125, there will be 100 units demanded, at a price of 100, there will be 200 units demanded.

00:35 At a price of 75, 300 units.

00:39 At a price of 50, 400 units.

00:43 At a price of 25, 500 units.

00:47 This is not perfectly to scale, but our demand curve will take that shape.

00:54 For our supply curve, we are told that at a price between 0 and 25, there are 100 units demanded.

01:02 About halfway there.

01:05 At a price of 25 there are 200 units.

01:10 Between 25 and 50 is 300 units.

01:14 The price of 50, 400 units supplied.

01:18 And finally, at a price between 50 and 75, 500 units is the quantity supplied.

01:25 Our supply curve will take this shape.

01:31 Now, we did this because our supply curve in this case is actually marginal private cost.

01:39 And we are told that the marginal social cost is double the marginal private cost.

01:47 So for each of these prices, we can take that price and double it to find the points on our marginal social cost curve...

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