Question

1. Using a          supply           and     demand         diagram,        demonstrate how    a          negative            externality   such   as        pollution       leads to        market          inefficiency. How            might the      government help    to        eliminate      this     inefficiency? What are      the            environmental        policy options          in        Developing   Countries?   

           

Answer 1

Externalities are either negative or positive impacts of economic transactions on third parties. These are also called side effects.

In case of negative market externalities, Firm tends to over produce and thus, it causes economic inefficiencies. Government can eliminate such inefficiencies by imposing taxes or other regulations. Following is diagram:

In above diagram, PMC is not true supply curve, it does not include social marginal cost. While if social marginal cost is included, there shall be rise Marginal cost of production. So output falls and price rises.

Options in developing countries:

• imposing pigou taxes.
• Offering subsidies to firm to use clean appliance and instruments.
• Use of rules and regulations.