In the article, the negative externality was the spilling of toxic chemicals that caused ‘large-scale environmental pollution’. The full cost of this polluting is not reflected in the market prices of the goods that the Biaoxin Chemical Company produces. Moreover, even though the company does offer job opportunities to the local population, the company causes a greater social cost to the people than the social benefit that can be gained through the income of the jobs. Many people have already been affected by the welfare loss that the polluting, which has been going on for several years, has caused. Additionally, in developing countries and in economies in transition, regulations are often inefficient, as corrupted officials ‘overlook’ these policies or laws, as seen in China, where ‘such directives are often ignored’.
Negative externality of production
Price of MSC MPC
chemicals Welfare loss
Negative externality
P*
P1
MSB
Q* Q1
Quantity of chemicals
Because the spilled toxic chemicals in the article are harmful to the local people, the Marginal Social Cost, MSC, is much greater than the Marginal Private Cost, MPC. The MPC and any external costs together make up the MSC. However, as the MPC is below the MSC, because there is an extra cost to the society as a whole that is caused by the pollution, a welfare loss is created, making this situation an example of a market failure. Moreover, in a negative externality, the quantity produced, Q1, and the price of the good, P1, are greater than the optimum quantity, Q*, and the optimum price, P*, which demonstrates that the chemicals produced by the firm are an overproduced demerit good.
As this is a free market, the situation with the Biaoxin Chemical Company would not change, because companies try to maximise their profits, meaning that they want to get the most efficient production from their resources, and sell their good at lowest possible quality at the highest possible price. Moreover, these profit maximising firms are only concerned about the private costs of production, not the social costs they might create through the production of demerit goods. Furthermore, many companies from developed countries move their factories into developing countries like China, because their legal structure is weak, and health and safety regulations are lenient, if at all existent. These weak institutional frameworks are a problem for the developing countries because they are barriers to economic growth and development, and some companies fully exploit them. Companies have to spend less money on health and safety measures, therefore have more money available to procure other factors of production. Also, if these firms are accused of wrong doing, they can bribe their way out of trouble. Because of such exploitations, situations like the pollution caused by the Biaoxin Chemical Company occur, in which the company is just concerned with making a profit and are unperturbed by the social costs they cause. To prevent such exploitations, developing countries need to spend money on creating a tighter legal structure. However, this might prevent foreign companies from entering the country which would lead to a loss of job opportunities for the insidious population and lead to a decline in the sharing of technical know-how with the developing nation. However, these companies represent a greater social cost than the benefits gained from the firms are worth and ways to reduce the exploitations therefore have to be found.
‘Two arrests over water contamination’, The Economic Times, 23/02/2009