Question

(3.) Imagine that a government project purchases such a large amount of an input that is sold in a competitive market that the price of the input increases. Discuss whether the project's budgetary expenditure on the input is likely to be an appropriate measure of the social cost of the purchase or shadow pricing is likely to be necessary. (NOTE: Illustrate your discussion with a diagram.]

Answer 1

Shadow pricing is the process of estimating the pricing of some intangibles of we can say that the prices of ones which are not usually calculated. However, social cost of purchase refers to the total cost of private costs and external costs.
Hence we can easily say that the budgetary expenditure on the input is not likely to be an appropriate measure of the purchase or we can say shadow pricing will not take place because the cost incurred on the inputs is neither the private cost nor the external cost.

For this diagram it can be illustrated that when demand for the input have increased then the demand curve shift righward resulting the price is rises

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