Question

The free market equilibrium maximizes the total surplus unless

A. Third parties are affected by the transactions of buyers and sellers

B. One or more sellers has the power to influence the price

C. There are costs to society not entirely born by buyers and sellers

D. All of the above

Answer 1

The free market equilibrium maximizes total surplus unless there arise market failure or externalities.

Market failure happens when one or more sellers (in monopoly) or buyers(in monopsony) has market power through which they can effect prices in their favor. In monopoly, Producer is able to affect price and charge higher which increases producer surplus but at the cost of consumer surplus. They also generate a deadweight loss to the society due to imperfect competition.

In case of externalities, either market participants( buyers and sellers) do not take into account the effect on third party or there are external costs that are uncomputable. For example, pollution. Pollution is created when goods are produced. The buyers and sellers of the good doesn't take the negative effect of pollution while marking their decisions and there is a deadweight loss. Moreover, other people, who are not buyers of that good have to face /tolerate the pollution. Thus, in case of externalities also the market outcome is not the surplus maximizing outcome.

The correct answer is option D. All of the above.

As I have explained, all other three options are indicators of imperfect competition and externalities.