The figure below shows the supply and demand curves for jeans in Smallville. The equilibrium price will NOT lead to the largest possible total economic surplus if:
A)jeans are purchased by consumers with reservation prices greater than $40.
B)the market for jeans is perfectly competitive.
C)the production of jeans generates air pollution.
D)there are diminishing returns in the production of jeans.

Question

The figure below shows the supply and demand curves for jeans in Smallville.  The equilibrium price will NOT lead to the largest possible total economic surplus if:
A)jeans are purchased by consumers with reservation prices greater than $40. 
B)the market for jeans is perfectly competitive. 
C)the production of jeans generates air pollution. 
D)there are diminishing returns in the production of jeans.

Quizplus · Accepted Answer

If the supply and demand curves do not capture all of the costs and benefits associated with the production and consumption of a good or service, then the market equilibrium will not be efficient. In this case, if the production of jeans generates air pollution, then this cost will not be reflected in the market supply curve, since the market supply curve only reflects firms' production costs.

The Figure Below Shows the Supply and Demand Curves for Jeans