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. The marginal social cost is equal to the marginal private cost plus the external costs.

We can clearly see from the diagram that the marginal private costs for the firm are lesser than the marginal social costs. Thus, there is a cost to the society which is caused by the pollution of the river due to the industrial waster generated by the firm. This may result in diseases like Jaundice , Cholera in the community and may hinder local tourism. The leather firm will be only concerned with its private costs and continue to produce at Q1.

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It will not produce at the socially optimum level of output where MSC ( marginal social cost) is equal to MSB (marginal social benefit)

This represents a misallocation of resources. Too much is being produced at too low a price. This can be considered a type of market failure due to negative externalities.

The welfare loss to society due to extra units from Q1 to Q2 is represented by the shaded area

The second types of negative externalities are negative externalities of consumption

Negative externalities of consumption:

When a product consumed by an individual adversely affects a third party ...

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