Question

Suppose that a firm is located along a river. The firm uses water from the river to cool its machinery and returns the water to the river several degrees warmer, which has led to a decline in the fish population downstream. The damage to the downstream fish is a(n) _________.
A) relevant cost of production to the economy.
B) irrelevant cost of production to the economy because fish are not participants in the economy.
C) relevant cost of production to the economy only if the firm is charged a fine for the damage done.
D) relevant cost of production to the economy only if there are commercial fishing activities downstream.
E) implicit cost of production which the firm will take into account in determining profit maximizing output.

Answer 1

Answer:

A) Relevant cost of production to the economy.

Explanation:

What the question is describing is what in economics is known as an externality. An externality is a consquence of the economic activity of a firm or a person, that affects in some negative way other people, and that is not paid for by the person of firm that causes it.

Pollution is the most well-known example of an externality. For example, when a coal plant contaminates the air, the people who live in the area breathe a low quality air and eventually get sick more often, spend money on the a doctor, and these medical costs are not paid by said coal plant.

In the question, the company is destroying the fish population of the river, and these loss of life damages the whole ecosystem of the area, which produces negative effects for all living organisms, including humans. Whether the company pays or not for the negative effects is only helpful if the fines really amount to the cost of the deterioration of the ecosystem (which usually do not).