Question

1. Imagine a beekeeper, who produces honey and sells it at a constant price per kilogram.
   1. Draw a diagram with the quantity of honey on the horizontal axis, showing the marginal cost of honey production as an upward-sloping line, and the price of honey as a horizontal line. Show the amount of honey that the profit-maximizing beekeeper will produce.
   2. For the beekeeper, the marginal private of producing a kilo of honey is equal to the price. But since the bees benefit a neighboring farmer, by helping to pollinate her crops, honey production has a positive external effect. Draw a line on your diagram to represent the marginal social benefit of honey production. Show the quantity of honey that would be Pareto efficient. How does it compare with the quantity chosen by the beekeeper?
   3. Using the definition of Pareto efficiency, explain why the equilibrium when externalities are not take into consideration is not efficient.

Answer 1

In the graph above, we see the horizontal line of PMB (price) as the bee keeper is willing to sell any quantity at a fixed price. As the neighbors benefit from the bee keeping acitvity, social benefit is greater than personal benefit. So, SMB curve (Social marginal benefit curve) is higher than PMB (private marginal benefit) curve. As a result of this equation, the equilibrium point of social  benefit is higher than the original equilibrium point of private benefit. Thus socially optimal quantity Q1 is greater than the private optimal quantity, Q.

Thus, pareto efficient quantity is Q1 while the quantity chosen by the bee keeper is Q.

Pareto efficiency: Pareto efficiency can be defined as a situation where no individual or party can be made better off without making atleast one individual or party worse off.

In positive externality, the private economy lacks incentives to create an outcome that is beneficial to the larger society; therefore resulting in losses in Pareto efficiency. Therefore, government intervention is required to motivate individuals like the bee keeper to produce a socially optimal output so that the other individuals can benefit from bee keeping without making anyone worse off. Thus the Parto efficient Q1 output can be produced.