Question

The Australian Blueberry Growers’ Association recently reported findings that blueberry flowers provide a good source of nectar to the beekeepers to help produce more honey.

(a) Using an appropriate diagram, show the perfectly competitive equilibrium in the Australian blueberry market. Also show the quantity of blueberries that would maximise social surplus. Is this equal to the market equilibrium quantity? Fully explain your answer. [4 marks]

(b) Why would deadweight loss occur in this market? Identify the area for deadweight loss in your diagram, and explain how you derived your answer. [3 marks]

(c) Discuss how the government could help to ‘internalise’ the externality using a market-based policy. [3 marks]

Note: Use only ONE diagram to illustrate your answers for parts (a), (b), and (c).

Answer 1

Consider the following diagram: Price Supply/ Private cost Supply+Subsidy Deadweight Loss Social value Demand QQ Quantity (a) In case of perfect competition, equilibrium will be at point where the supply (i.e., private cost) equals demand (i.e., private value). Therefore, in the above diagram, equilibrium will be at point E, where the market equilibrium quantity will be at Q, and price will be at P. Production of blueberry provides benefits to the bee hives, as bees can prepare honey from the blueberries. Therefore, producing blueberries impose a positive externality on the environment. However, the social equilibrium will be at point where the supply curve equals social demand curve (i.e., the market demand curve plus the marginal benefit). Therefore, social equilibrium will be at point E', where the quantity is Q, and the price is P'. (b) Deadweight loss is shown as the red shaded triangle in the above diagram. Socially optimum level of output is Q’, however, market clearing output is Q. Therefore, there is under production in the case of market equilibrium, which leads to deadweight loss.

To internalize the negative externality, taxes should be imposed. However, since blueberry production leaves a positive externality, it should be internalize using the subsidies. Giving subsidy to the producers will reduce their cost, and will increase the supply, shifting the supply curve to the right, as shown in the diagram. This will lead to the new equilibrium point E", where market clearing quantity produced will be equal to the socially optimal level. Q?while the price will fall.