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Microeconomics Coursework - Minimum wage

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Microeconomics Coursework - Krithika Narayan Negative externalities are the undesirable effects of the consumption or production of a good on 'outsiders' (individuals or firms) that are not accounted for in the private market (market for private firms and individuals) and are therefore called 'spillover' effects. For example in the case of tobacco, the negative externalities are health and are risks to the users and the people around them, pollution of the surrounding areas, addiction etc. It is a type of market failure. Market failure is when a market works badly or is absent completely. In this case, the market is overproducing tobacco therefore it is a market failure. This indicates that the social benefit is less than private benefit i.e. benefit to individuals. This can be shown in the market diagram for tobacco. ...read more.


One solution to reduce the consumption of tobacco is to increase the tax on tobacco as a whole instead of on cigarettes or tobacco pouches. The supply will therefore shift to the left. This is shown in the diagram below. Market for tobacco S2 D S1 P1 P2 P3 Q2 Q1 Quantity of tobacco (thousands of tones) Because the tax is an ad-valorem tax, supply will be steeper because as the price increases, the tax also increases. The vertical difference between the curves at any point will be the tax at that price on the original supply curve (S1). At the original price P3, the tax charged is P1-P3. Consumers pay only �P1-P2 (striped region) and the remaining tax (�P2-P3-checked region) is paid by the firm. This causes the price to rise, which causes a movement along the demand curve. ...read more.


This theory of negative externalities is directly relevant to the issue of tobacco consumption. However, there are certain drawbacks. The market diagrams for these will be extremely hard to construct. Data will need to be collected from a great number of people for the demand curve to be accurately drawn. Also, this theory assumes all other factors that affect demand and supply to be constant. The negative externality, in many cases, is not possible to quantify. Therefore it is not possible to accurately calculate by how much the demand would need to be decreased by. It is, however, useful to have this theory applied because it does tell us that demand needs to be decreased, though extremely roughly. Therefore, it is crucial to look at the matter from an economic perspective to gain insight as to how to move forward to solve these issues. 1 A demerit good is one that is overvalued by the consumer and is supplied at a price that is relatively low. ...read more.

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