Question

An industry producing chemicals shows the following marginal cost function: MgCp = 5+2X Where X is the quantity produced. The demand for X is represented by the following function: P = 20 – 2X. Assume that the market is perfectly competitive and unregulated.

In the productive process the firms throw their wastes throw their wastes in a river, the society is facing a cost for the firm’s actions. The social marginal cost is given by the following function MgCs = 5 + 3X B)

b) If the market is perfectly competitive and unregulated the resource allocation is inefficient, explain.

Answer 1

In perfectly competitive market equilibrium is at P = MC

20-2X =5 +2X

4X = 15

X = 3.75

But here the society faces a social cost for throwing waste in the river, so the equilibrium should be at P = SMC

20-2X = 5+3X

5X = 15

X = 3

b) If the market is perfectly competitive and unregulated, then the market produces a higher amount of X and in this process throws much more waste and increases the social cost for the society.

But if it takes into consideration the social marginal cost for production it can reduce its waste and be beneficial for society. Hence, if the market is perfectly competitive and unregulated the resource allocation is inefficient.

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