Why shadow price is called the economic price?

Shadow Pricing is the genuine economic prices of products and services after they have been suitably adjusted by eliminating distorting market instruments and factoring in the social effect of each commodity or service.

The shadow price of any good is the increase (reduction) in social welfare that results from producing one additional (fewer) unit of that good. Consequently, the shadow price of carbon (SPC) is defined as the social cost of emitting a marginal tonne of carbon (or the social benefit of abating a tonne), similarly to the SCC. A shadow price is often calculated based on a group of assumptions and estimates because it lacks reliable data, so it is subjective and somewhat inaccurate. SPC?has its advantages and drawbacks, which are shown in the figure below-

Fig. 1- Characteristics in terms of pros and cons of a shadow price

It plays a crucial role in areas where it is difficult to evaluate the worth of things, particularly qualitative and valuable items for the decision-making process of the business's purpose.

• The estimation of capital prices, foreign exchange rates, etc. through shadow pricing is required for the development of public sector programs under public policy.
• Analysis of the Project: It is based on a cost-benefit analysis that compares expenses and benefits. It is an outstanding instrument for evaluating any project, and decisions may be made accordingly.

Although shadow pricing has typically been utilized in government-led research, its usage in the private sector is on the rise as businesses attempt to examine the societal implications of their activities. As demand for Environmental, Social, and Governance (ESG) investing has increased, so has the need for corporations and investors to examine the social effects of their production and investment decisions. The pledges made by the majority of multinational firms to reduce their CO2 emissions and acknowledge the impact of their economic operations on society is indicative of this trend.???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????

The graphs below demonstrate how shadow pricing might impact resource allocation efficiency. Figure 2 depicts a positive shadow pricing where societal marginal costs are smaller than private marginal costs. Vaccinations are an example of this since they help society as a whole by preventing the spread of disease.?Social Marginal Cost (SMC) equals Private Marginal Cost (PMC) minus the net social benefit of vaccination.

Fig. 2- depicts a positive shadow pricing where societal marginal costs are smaller than private marginal costs.

The negative shadow price seen in Figure 2 occurs when the social marginal cost exceeds the private marginal cost. An example of this is pollution, in which the disposal of harmful waste chemicals into rivers has a detrimental impact on fish stocks in the region, hence lowering the revenue of local fishermen. Social Marginal Cost (SMC) is the PMC minus the net social cost of disposing of dangerous waste substances.

Fig. 3- depicts the negative shadow price, which occurs when the social marginal cost exceeds the private marginal cost.

To increase trust in the SPC employed in economic evaluation, I believe that estimations of the marginal abatement cost (MAC) can play a role. It would be imprudent to replace the SCC with these estimations, but they can work in tandem.

Fig. 4 -explains the graphical method of finding the shadow price with MAC and SSC curves.

Conclusion

There is an obvious need for more research on this topic. Numerous researchers have detected the issue, yet they are uncertain of the answer. In addition, they did some preliminary research and showed that, particularly for affluent nations like the United Kingdom, the 'national' SCC can be quite distinct from the 'global' SCC that has been the primary focus of the literature to until.