Analysis of Production Externalities and Market Inefficiency

A factory producing industrial solvents is located upstream from a popular fishing spot. The factory's production process releases a chemical byproduct into the river that, while not illegal, harms the fish population. The factory manager, aiming to maximize the company's profit, sets the production level where the market price of solvents equals the factory's own marginal cost of production. Which statement best analyzes the economic efficiency of this outcome?

Evaluating Economic Efficiency with External Costs

A company's decision to produce at the quantity where the market price equals its private marginal cost will result in a socially optimal allocation of resources, even if its production process imposes costs on third parties.

Match each economic term with its correct definition. These terms are used to analyze situations where a producer's activity imposes uncompensated costs on others.

Explaining Market Inefficiency with External Costs

An economist is analyzing a market where a factory's production pollutes a nearby river, harming a local fishery. The factory is a price-taker and maximizes its own profit. Arrange the following statements into the logical sequence that demonstrates why the factory's chosen output level is not socially optimal.

A chemical factory is a price-taker in the market for fertilizer, where the price is $100 per ton. The factory's production creates a negative externality for a downstream fishery, costing the fishery$20 for each ton of fertilizer produced. For the overall economic outcome to be efficient, the factory should operate at an output level where its own marginal cost of production is $____.

A leather tannery, operating in a competitive market, dumps waste into a river. This practice harms a downstream community that relies on the river for clean water. The tannery produces at the output level where the market price for leather equals its own marginal cost of production. An economist claims: 'From an economic efficiency standpoint, the tannery is producing the 'correct' amount of leather because it is responding perfectly to market price signals.' Which of the following statements provides the most accurate critique of this claim?

Analyzing Production Decisions with Negative Externalities

Pareto Inefficiency Example: Banana Plantations and Fishermen