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 production of jeans generates air pollution, then the marginal social cost of producing jeans will be greater than the marginal private cost, which means that the supply curve will shift upward and to the left from where it currently lies. This will result in a higher equilibrium price and a lower equilibrium quantity, which will reduce consumer surplus and producer surplus and therefore result in a smaller total economic surplus. Therefore, the equilibrium price in this situation will not lead to the largest possible total economic surplus.

The Figure Below Shows the Supply and Demand Curves for Jeans