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Question

Difficulty: MediumEnvironmental Degradation, Issues, and Resource Management

Unregulated industrial effluent discharge into rivers by manufacturing firms in Nigeria creates uncompensated pollution costs borne by downstream agricultural communities. From an economic perspective, which of the following best describes this environmental issue and its effect on market resource allocation?

  1. It represents a negative externality, causing social costs to exceed private costs and resulting in over-allocation of resources to the polluting activity.Answer
  2. B
    It represents a positive externality, causing private benefits to exceed social benefits and resulting in under-production of manufactured goods.
  3. C
    It represents a opportunity cost distortion where private money costs rise above social costs, causing an inward shift of the production possibility curve.
  4. D
    It represents a market failure stemming from commercialization, which can be fully rectified by transferring enterprise equity ownership to private shareholders.

Answer

The pollution issue represents a negative externality where social costs exceed private costs, leading to an over-allocation of resources toward the polluting production activity.
When manufacturing firms discharge untreated waste into water bodies without compensating affected communities, they create a negative externality. Because the firm pays only private costs and ignores external costs, Marginal Social Cost exceeds Marginal Private Cost. Consequently, the market price is lower and production is higher than socially desirable, causing an over-allocation of economic resources to the polluting sector.

Step-by-Step Solution

1
Identify the nature of the environmental cost imposed on downstream communities
The damage to farming communities is an uncompensated third-party cost, which constitutes a negative externality.
When a firm's production creates costs for society that are not accounted for in the firm's private cost structure, a negative spillover occurs.
2
Compare social costs and private costs
Marginal Social Cost (MSC) = Marginal Private Cost (MPC) + Marginal External Cost (MEC). Therefore, MSC > MPC.
Without government intervention or environmental regulations, profit-maximizing firms produce where Marginal Private Cost equals Marginal Revenue.
3
Determine the resource allocation outcome in the market equilibrium
The free market output is higher than the socially optimal output, meaning resources are over-allocated to the polluting industry.
Because the market price does not reflect the full social cost of production, excess output is produced, creating deadweight welfare loss.

Key Concept

Negative Externalities and Market Failure in Resource Management
Estimated Time:1m 0s
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Topics

Environmental Degradation, Issues, and Resource Management