Question

Assume that the (U.S.) Environmental Protection Agency determines that that hydraulic fracking adversely impacts drinking water resources under certain circumstances. If so and if uncorrected by public policies or otherwise, then

a. the market price of natural gas reflected in the competitive markets is too low

b. the market output of natural gas reflected in the competitive markets is too low

c. the market price of natural gas reflected in the competitive markets is socially optimal

d. the market price of natural gas reflected in the competitive markets is too high

Answer 1

If the cost of impact on the drinking water resources is not considered, then the cost of production perceived by the producers/firms would be less than the actual total costs. Hence, in such a scenario, the supply would be higher than the socially optimal supply (as shown in the above figure)

As observed from the above graph, the market output of natural gas would be too high compared to the socially optimal output in the given scenario and the market price would be too low.

Ans: a. the market price of natural gas reflected in the competitive markets is too low