How Would an Economist Determine the Optimal Amount of Pollution - Assignment Example

1. How would an economist determine the optimal amount of pollution? How can the optimal level of efficiency be reached? Which intervention would create the least deadweight loss? It is widely accepted that pollution negatively affects surroundings and humanity is supposed to reduce environmental damages. So, at the first sight the optimal level of pollution is zero; however, we need to consider the fact that in order to use various creature comforts people need to produce them firstly and this process is entirely connected to environmental pollution. According to Beardshaw, the optimal level of pollution is reached on condition that the marginal damage (MD) from pollution is equal to the marginal benefit (MB) of pollution. In order to attain the optimal level of efficiency, world society need to hold their business in such way, so the balance between social costs of pollution, which include various environmental damages, health aggravation, etc., and social benefits from pollution, which are associated with lower production costs and thus, higher effectiveness, would be kept. In order to reach the least deadweight loss, economic agents need to support Pareto efficiency, which states that any economic system is not Pareto optimal if there is a place for some changes in goods allocation that would benefit certain individuals while the others would lose nothing. 2. Evaluate the following statement “Government always makes the economy more efficient”. Is this statement true or not? Support your argument with examples or counterexamples as necessary. Governments control the overall development of economic situation in their countries by implementing fiscal and monetary policies. The impact of government interruptions in economy depends on such factors as whether the interruptions are well-though and have reasonable background, whether it is an appropriate time to implement the changes, etc. Therefore, the statement “Government always makes the economy more efficient” is untrue and in order to confirm this we would examine American economy. Negative impact. In 2007 American government had federal debt about $9 trillion and in 2010 it was approximately $14 trillion, which are quite significant amounts. A lot of economists consider that such high level of public debt and its tendency to grow are very dangerous indicators. Such situation could easily lead to undesirable inflation, interest rates increase and price instability. Positive impact. American government has reached quite good results applying well-thought and reasonable fiscal and monetary policy, which essentially strengthen their economic position in the world. Due to wise and consequent coordination, American economy demonstrates stable growth and rather high employment rate. 3. How does a monopolist determine the optimal price and quantity of production? Monopolists produce less goods and set higher prices for their goods than economical agents in competitive markets. In monopolies there are no rivals, so monopolist could settle the price for its products and change production volumes disregarding the risk that other firms would entice their consumers. According to Beardshaw, monopolistic firms choose the optimal quantity of production when the equality MC=MR holds (marginal costs equals marginal revenue), which allows them to maximize the profit. Monopolists are free to settle the price for goods produced as they have no competitive and set it above the value of marginal cost. The optimal price’s upper boundary is defined by consumers’ possibilities to buy the products of high price (by demand curve). Furthermore, monopolies are often associated with price discrimination, which means that monopolists are able to charge different prices for different consumers. It could be explained with the fact that consumers have various financial possibilities and thus, each of them has the maximum price, which they agree to pay for certain product. Such situation could be described graphically by perfect coincidence between monopolists’ marginal revenue curve and consumers’ demand curves. 4. Will a competitive market induce an efficient level of production of a good if there is an externality in production or consumption? Why or why not? Pure competition is described with a huge amount of firms, which produce standardized products, and any individual company cannot change the general situation in the market by oneself. In order to maximize their profit, competitive firms settle the price equal to the marginal costs and in such way reach allocative efficiency. According to Coase theorem, efficient allocation of resources and optimal level of production is possible in markets, which provide conditions for perfect competition, complete information, and no transaction costs, and in such case the efficiency is not dependant on market externalities. However, the model of pure competition is unrealistic as in real world there always exist a group of leaders that have more power to define future trends and could affect prices essentially while consumers get asymmetric information about market changes. All these externalities mean that theoretical rules and equations, which describe the state of efficient level of production, are violated. Consequently, real world markets are not able to reach the maximum efficient level of production and it is possible just to approach its value. 5. Why do firms exist, according to economists? Give three reasons for full credit. It is a human nature to create some groups of like-minded people and try to reach their mutual goal together. In economic terms, there are three main reasons why firms exist: cooperation with persons, who hold the same views, could provide wider possibilities to develop and thus, results in more effective performance. Different people generate fresh ideas how to solve business problems, which leads to better results; market communities are able to acquire more financial capital in total and as a result, they have more possibilities to produce larger amounts of goods. The increase in scale of production, processing, etc. could decrease transactions costs significantly and in such way provide quite attractive benefit for organization than individual agents in market; it is supposed that economy evolves faster and becoming more efficient when there is a competition in the market, which is possible just in case there exist a lot of companies and institutions. All the abovementioned findings are confirmed with Coase theory, which states  that firms and companies exist if some people prefer to be governed and instructed; if some people prefer to govern instead of be directed; if consumers prefer to buy products from firms, not individuals. Reference 1. Beardshaw J., 2001. Economics: A students guide. Harlow: Prentice Hall. Read More