When do negative externalities of production occur
When social costs (MSC) are greater than private costs (MPC)
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Model a negatuve externality in production
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Where is the free market equilibrium
S=D, MPC=MPB, Pfm, Qfm
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Where is social welfare maximised
MSC=MSB, Qso=Pso
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Why is there market failure with negative exteranilities in production
Market forces results in too much electricity being produced (Qfm-Qso), electricity becomes too cheap (pso-Pfm) to bring about socially optimum level of consumption
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Why is there a triangle of welfare loss in negative externalities in production
for units of output Qso-Qfm, the social cost of producing each unit of electricity is greater than the benefit derives from each unit produced, society would be better off if these units weren’t produced
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When do positive production externalities occur
When Private costs (MPC) are greater than Social costs (MSC)
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Model a positive production externality
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Where is the free market equilibrium in positive production externalities
S=D, MPC=MPB, Pfm=Qfm
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Where is social welfare maximised in a positive production externality
MSC=MSB, Pso=Qso
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Why is there market failure in a positive production externality
Market forces result in too little electricity being produced (Qso-Qfm), electricity becomes too expensive (Pfm-Qso) to bring about socally optimum level of consumption
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Why is there a triangle of welfare gain in positive production externalities
For Units of output Qfm-Qso the social benefit of producing each unit of electricity is greater than the cost society incurs from each unit produced, society would be better off if these units were produced.
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Define externalities
third party spill over effect
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Define government intervention
an action carried out by the government that affects the market with the objection of changing the free market equilibrium
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Define market failure
when the price mechanism fails to allocate scarce resources efficiently leading to a net social welfare loss
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Why are negative production externalities an example of market failure
true costs of production are under-reflected, leads to underpriced output, causes allocative function of prices to fall in that too much of good gets produced and consumed
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Define an indirect tax
tax levied on the producers of goods and services
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model an ad velorem tax on a negative production externality
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Model a direct tax on a negative production externality
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