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Essay on negative externalities

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Explain the concept of negative externalities: A spillover effect associated with production or consumption that extends to a third party outside the market. In other words, an external effect that generates costs or benefits to the third party is known as an externality There are two types of negative externalities 1)Negative externalities of production These externalities occur when production of goods and services creates external costs that are damaging to third parties. For example, Consider the example of a firm producing negative externalities. A chemical factory discharges its waste products into a local river. This kills off the fish stock and causes illness amongst water sports' enthusiasts who use the river for recreational purposes. Here in this case , there is a cost to the community greater than the costs of production paid by the firm. The firm is creating external costs in this case. Thus , the marginal social cost of production is greater than the marginal private cost. ...read more.


They do not care aout the negative externalities that they are creating. They will continue to buy Q1 cars at a price of P1. The socially acceptable output should be Q2. Thus , the consumers are consuming Q1 to Q2 extra cars. Since marginal social cost is greater than marginal social benefit , it causes a welfare loss to the society and thus , has negative externalities. In a free market , this situation will continue because consumers and producers are bothered only about their own private costs. The government needs to take measures to reduce these external costs of production . Part 2 Evaluate three policies that may be used by government to reduce external costs of production. Negative externality of production occurs when a firm creates external costs that are damaging to third parties. Above is a representation of a car factory having negative externalities of production .We can clearly see from the diagram that the marginal private costs for the car factory are lesser than the marginal social costs. ...read more.


To meet the standards, the firm would have to spend money, thus increasing their private costs and forcing them to restrict output. A problem with this solution is that the ban or restriction could lead to job losses and non consumption of the product which might be valuable . Also ,the setting and implementation of the policy standards may be long and debatable and might involve hidden costs. 3) The government could issue tradable emission permits. These are a market based solution to negative externalities of production. These licenses are created by the government and give the firm license to create pollution up to a certain level. Once they are issued , firms can buy , sell and trade the permits on the market. The government decides on the level of pollution it will permit each year and then split the total level of pollution into aq number of permits which will be given to different firms. The result is that if the firm pollutes higher than the quota, then it will have to buy permits from other firms which will raise its costs of production and thus force it to reduce production or to invest in Sustainable Development. ...read more.

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