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Economics Commentary- Market Failure. In the article, the negative externality was the spilling of toxic chemicals that caused large-scale environmental pollution[1]. The full cost of this polluting is not reflected in the market prices of

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Commentary 1 Negative externalities occur, when the production or consumption of a good or service creates an external cost that is damaging to a third party. These externalities produce costs to the society and environment, which are not reflected fully in the free market prices. The producers or consumers that cause these side effects impose those costs on others not responsible for instigating the effects, thereby leading to a market failure. For example, if a paint factory releases toxic fumes that are harmful to the local populace, then the social costs outweigh the private costs (costs born by a firm or an individual from the production or consumption of a good or service) and factors of production that the firm has to pay. The fumes emitted may cause cancer or respiratory problems in the people living nearby, thereby creating a larger social cost. Goods with a negative externality are called demerit goods. ...read more.


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. ...read more.


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. 1 'Two arrests over water contamination', The Economic Times, 23/02/2009 2 ibid ?? ?? ?? ?? ...read more.

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