Fig. 1 shows estimated costs and benefits from dredging gravel from a riverbed. Sediment released by dredging reduces nearby farmers' crop income. The compe...
Question 1 Report
Fig. 1 shows estimated costs and benefits from dredging gravel from a riverbed. Sediment released by dredging reduces nearby farmers' crop income. The competitive market uses MPC, while MSC includes the environmental damage.
(a) Which output is socially efficient: 40 tonnes or 70 tonnes? [1]
(b) State what MSC includes in addition to MPC. [1]
(c) Explain why the unregulated market produces 70 tonnes. [2]
(d) Calculate the overproduction of gravel each week. [2]
(e) Analyse the likely effects of a government tax on each tonne of dredged gravel. [9]
Answer Details
(a) The socially efficient output is 40 tonnes [1]. Social efficiency occurs where marginal social benefit equals marginal social cost, shown by the intersection of MSB and MSC.
(b) MSC includes the external cost in addition to MPC [1], here environmental damage that reduces farmers’ crop income.
(c) Dredging firms base their supply decision on marginal private cost [1]. The unregulated equilibrium is therefore where MPC equals MSB, at 70 tonnes, rather than where MSC equals MSB [1].
(d)
\[70\text{ tonnes}-40\text{ tonnes}=30\text{ tonnes}\]
Overproduction is 30 tonnes per week [2].
(e) A per-tonne tax increases the private cost of dredging [1]. The supply curve based on MPC shifts upwards towards MSC [1], increasing the market price of gravel [1]. Quantity demanded and quantity supplied decrease [1], so output may move from 70 tonnes towards the efficient 40 tonnes [1]. Less dredging reduces sediment and damage to crop yields [1], so farmers’ incomes may increase [1]. The government receives tax revenue, which could finance river restoration or compensation [1]. However, a tax that is too low leaves overproduction, whereas one that is too high could reduce output below 40 tonnes and raise construction costs [1].
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