Question

Soybeans are produced and sold in a perfectly competitive market. The fertilizers used in soybean production generate a negative externality by seeping liquid contaminants into local rivers.

(a) Draw a correctly labeled graph of the soybean market, and show each of the following.

Answer 1

In a perfectly competitive market, supply and demand curves for soybeans reflect private costs, ignoring negative externalities from fertilizer runoff. Introducing the marginal social cost curve to include these externalities shows a market failure where true societal costs exceed benefits, leading to overproduction.

Step-by-step explanation:

The student's question relates to the production of soybeans in a perfectly competitive market and how fertilizers used in this production create a negative externality by contaminating local rivers. To illustrate this, we can use a graph that shows the supply and demand curves for soybeans. The supply curve in this context is based on the marginal private cost (MPC), which only includes the private costs incurred by the farmers, such as the cost of fertilizers, seeds, and equipment.

However, this supply curve does not consider the external costs imposed on society, such as the environmental damage from fertilizer runoff. To account for this, we introduce a marginal social cost (MSC) curve that lies above the MPC curve since it includes both private costs and the negative externality's additional costs. In an ideal situation without externalities, the intersection of the supply curve (MPC) and the demand curve determines the market equilibrium, where the quantity produced and price reflect the true cost of production.

When negative externalities are present, the market equilibrium represents a point where social costs exceed social benefits, leading to overproduction of soybeans compared to the socially optimal level. The socially optimal point would be where the MSC intersects with the demand curve, leading to a higher equilibrium price and lower equilibrium quantity. This discrepancy demonstrates a case of market failure, where the private costs borne by producers do not align with the true costs to society.

Answer 2

In a perfectly competitive market, soybean production that includes a negative externality such as pollution from fertilizers leads to a higher quantity produced than the social optimum, indicating market failure. The intersection of the marginal social cost (MSC), which accounts for externalities, with demand represents the socially optimum production point, which is lower than the market equilibrium based solely on marginal private cost (MPC).

Step-by-step explanation:

Soybeans, as described in this context, are produced in a perfectly competitive market, where the product is fairly homogenous, and producers are price takers. In such a market, the interaction of demand and supply typically coordinates social costs and benefits effectively. However, the presence of a negative externality, such as pollution from fertilizer runoff, throws a wrench into this ideal interaction.

To illustrate the impact of a negative externality in a perfectly competitive market, consider a graph where the horizontal axis represents the quantity of soybeans, and the vertical axis represents the price. The supply curve, representing marginal private cost (MPC), slopes upward showing that as producers offer more soybeans, the cost to produce each additional unit increases. However, this supply curve does not take into account the social cost, which includes the negative externality of pollution.

To account for this, one must include the marginal social cost (MSC) in the graph, which is typically above the MPC due to the added external costs of pollution. The intersection of MSC and demand would show the socially optimal point of production, which is typically at a lower quantity and higher price than what the market with only MPC would determine. This discrepancy highlights the market failure due to the negative externality since the market equilibrium reflects neither the true cost of production nor the social optimum.