Negative externality

Full Answer Section

      The following graph shows the market for steel when firms are dumping their industrial waste in the local waterways: [Graph of the market for steel showing the market price and quantity when the firms are dumping their industrial waste in the local waterways] The supply curve for steel is S, and the demand curve is D. The market equilibrium price and quantity are P* and Q*, respectively. When firms dump their industrial waste in the local waterways, they are imposing a cost on society that is not reflected in the market price of steel. This cost is represented by the external marginal cost (EMC) curve, which is above the supply curve S. The socially optimal level of output is Q**, where the marginal benefit of steel production is equal to the marginal social cost, including both the private marginal cost and the external marginal cost. Motivation for firms to pollute the local waterways Firms are motivated to pollute the local waterways because they can save money on waste disposal costs. However, this saving comes at a cost to society, as the pollution harms the environment and human health. Third parties adversely affected by the pollution Third parties who are adversely affected by the pollution include:

• People who live near the polluted waterways, who may suffer from health problems such as asthma and cancer.
• Businesses that rely on the waterways, such as fishing and tourism businesses.
• The government, which may have to spend money to clean up the pollution.

How the negative externality can be internalized There are a number of ways to internalize the negative externality of pollution. One way is to impose a pollution tax on firms. This tax would increase the cost of production and shift the supply curve up to S'. The new market equilibrium price and quantity would be P' and Q', respectively. Another way to internalize the negative externality is to create a cap-and-trade system. Under this system, firms would be given a limited number of permits to pollute. Firms that pollute less than their allotted amount can sell their permits to firms that pollute more than their allotted amount. This would create a market for pollution permits, and the price of these permits would reflect the cost of the pollution. Graph showing the appropriate shift of the supply curve which will remedy the negative externality and bring about the socially optimal level of output The following graph shows the appropriate shift of the supply curve which will remedy the negative externality and bring about the socially optimal level of output: [Graph showing the appropriate shift of the supply curve which will remedy the negative externality and bring about the socially optimal level of output] The socially optimal level of output is Q**, where the marginal benefit of steel production is equal to the marginal social cost, including both the private marginal cost and the external marginal cost. To achieve this level of output, the supply curve must be shifted up to S'. This can be done by imposing a pollution tax or by creating a cap-and-trade system. Positive externality A positive externality is a benefit of production or consumption that is enjoyed by someone other than the producer or consumer. For example, when a person gets a vaccine, they not only protect themselves from the disease, but they also help to protect others by making it less likely that the disease will spread. Graph for the market for vaccine shots showing the market price and quantity The following graph shows the market for vaccine shots: [Graph of the market for vaccine shots showing the market price and quantity] The supply curve for vaccine shots is S, and the demand curve is D. The market equilibrium price and quantity are P* and Q*, respectively. The social benefit of vaccine shots is greater than the private benefit, as vaccine shots also generate positive externalities. The social marginal benefit (SMB) curve is above the demand curve D. The socially optimal level of output is Q**, where the marginal social benefit of vaccine shots is equal to the marginal social cost. To achieve this level of output, the demand curve must be shifted up to D'. This can be done by government subsidies or by public awareness campaigns. Conclusion Negative externalities and positive externalities can both lead to market inefficiencies. By understanding these concepts and how they can be internalized, policymakers can design policies that improve the efficiency of the market and promote social welfare.  

Sample Answer

   

Negative externality

A negative externality is a cost of production or consumption that is borne by someone other than the producer or consumer. For example, when a factory pollutes the air, the cost of that pollution is borne by people who live nearby, even though they had no say in the matter and did not benefit from the factory's production.

Graph for the market for steel showing the market price and quantity when the firms are dumping their industrial waste in the local waterways