Question

1. a. Discuss the causes of market failure in the context of environmental economics

b. In a competitive market, competitive equilibrium is said to be not an efficient equilibrium. Explain this statement.  

c. Explain competitive equilibrium and efficient equilibrium using appropriate diagram.

d. Explain methods to achieve competitive equilibrium and efficient equilibrium using:

1. Marginal Social Benefit (MSB) = Marginal Social Cost (MSC)
2. Comparing marginal profit (Mir) and marginal external cost (MEC).

e. Use appropriate examples to explain negative externality and positive externality.

Answer 1

(a) Central to environmental economics is the concept of market failure. Market failure means that markets fail to allocate resources which are already scarce with full efficiency to all the individuals in the market and finally reduces the social welfare in the market. As resources are limited and can be extracted upto an extent, there is not equitable resources and income. Wealthy people hold a greater share of resources and produces maximum environmental pollution while poor people have less share on resources in the market. This reduces the welfare for poor and rich who extract the pollution in the society do nothing to reduce the pollution or help environment situation improve because they are already getting enough income and do not have any incentive to reduce pollution. Such a gap implies wastefulness of resources or economic inefficiency, resources can be reallocated to make at poor person better off without making anyone else worse off. Common forms of market failure include externalities, non-excludability and non-rivalry.

(b) The competitive equilibrium is an equilibrium condition where the interaction of profit-maximizing producers and utility-maximizing consumers in competitive markets with freely determined prices arrive at an equilibrium price. At this equilibrium price, the quantity supplied is equal to the quantity demanded by contrast an efficient equilibrium is an equilibrium in which the equilibrium is of more than one market. Competitive equilibrium could be of specific to one segment of the market while efficient market is where all the segment in the market have total quantity demanded = supplied. The difference between the two types of equilibrium is all about the emphasis. Any efficient equilibrium is a competitive equilibrium while the vice versa may not be true.

(d) (i) For the purpose of this analysis:

• Demand curve is equivalent to the marginal private benefit curve.
• Supply curve is equivalent to the marginal private cost curve.

Equilibrium comes when Private benefit = private cost. Q1 is the output level where both these curves intersect.

(ii) There could be two cases in Marginal Benefit can be compared to marginal cost. Monopolist case and perfect competition case. The above diagram here is perfect competition case where MR is constant and Marginal cost is rising. Output level is Q* in this case and in monopolist AR/MR is falling while MC is rising. Output level would be Q*. (e) Externality is the case which affects another person who is not involved even in the process. It could be positive and negative externality. Assume a case when there is an open free tuition classes for poor students in a village. Positive externality would be the when any student in the village can attend the classes which would increase the welfare in the society and increase the literacy rate. Negative externality comes when due to these open classes, people are living in that area are getting disturbed. Those rich students who are going to school are getting disturbed because the sound produced by mic in the locality disturb them and they are not being able to focus on their studies.