Question

Suppose there are several paper mills producing paper for a market. These mills, located upstream from a fishing village, discharge a large amount of waste water into the river. The waste material affects the number of fish in the river and the use of the river for recreation and as a public water supply source. What is the deadweight loss from producing at the market equilibrium

Answer 1

Deadweight loss occurs when negative externalities from paper mills' wastewater discharge lead to inefficient market outcomes and societal welfare loss.

Step-by-step explanation:

The deadweight loss from producing at the market equilibrium in the case of paper mills discharging waste into a river can be understood in terms of externality. Externalities occur when the production or consumption of a good affects a third party not involved in the market transaction, and they can lead to market failure.

In this scenario, the paper mills do not bear the full cost of the environmental damage they cause, thus oversupplying paper relative to the socially optimal level. This results in a deadweight loss, which is the loss of social surplus due to inefficient market outcomes, as delineated by areas U + W in the given figure.

Market equilibrium fails to account for the negative externalities, leading to overproduction of paper and underproduction of clean water resources and healthy fisheries. Consequently, the deadweight loss reflects the overall loss in welfare that occurs because of this market inefficiency.