Question

Explain why this equation promotes efficiency: P=MC=MR=MU. Where does the price signal fit into efficiency? Answer this in relation to the equation.

Define and give an example of a beneficial externality.

Define and give an example of a detrimental externality.

Answer 1

P=MC=MR is the equation which refers that price=marginal revenue=marginal cost which is used in markets which are perfectly competitive because in it, large number of firms are present and no firm can set the prices single handedly and every firm in the market is a price taker,so their marginal revenue equals the marginal cost and the price prevailing in the market.

At this point, a firm can maximise its profits in the perfect competition market and if the firm increases the production,the profits will decrease and if the production is decreased,the profit is not fully realized or maximum profits will not be earned.

So, this equation promotes efficiency as all the firms in the market will be able to maximise their profits,recover the cost and earn revenue to continue the business even when there are a large number of producers present in the market.A firm will not over produce or underproduce, will meet the cost of production and make profits thereby not incurring any loss or shock.

Beneficial Externality- refers to the situation where consumption or production of a good and services causes some benefit to a third party for example when someone consumes education,he not only gets benefit for himself,but also, for the whole society as with his knowledge,he can educate others and provide them benefit too.

Detrimental Externality- is directly opposite of beneficial externality as here a third party suffers the cost due to the production of some good and services after the producers and consumers for example pollution emitted from the factories that affects the health of everyone living in the surrounding environment.