Question

Suppose the production of cotton causes substantial environmental damage because the pesticides used by cotton farmers often make their way into nearby rivers and streams, and are very harmful to fish and other wildlife. If cotton farmers do not have to pay for the environmental damage caused by the pesticides used to grow cotton, then the market equilibrium price will be ______ and the market equilibrium quantity will be ______.A. inefficiently high; inefficiently low
B. inefficiently high; inefficiently high
C. inefficiently low; inefficiently high
D. inefficiently low; inefficiently low

Answer 1

Answer:

C. Inefficiently low; inefficiently high

Explanation:

This is a case of a negative externality. If the farmers were forced to pay the cost of this damage, the Marginal Private benefit of farmers will be less than the Marginal Total cost and then they would produce less and the price will be higher.

When farmers don't have to pay the external cost they produce at

PMB = PMC ,

(PMB is private marginal benefit and PMC is private marginal cost)

If they had to pay external costs this equation would be as,

PMB < PMC + External Cost.

This raises total cost for farmers and thus they produce less with cotton at higher prices, as they have higher costs this way.

Therefore without these costs, the prices will be inefficiently low and quantity inefficiently high.

Hope that helps.