Micro: Production externalities

When do negative externalities of production occur

When social costs (MSC) are greater than private costs (MPC)

Model a negatuve externality in production

Where is the free market equilibrium

S=D, MPC=MPB, Pfm, Qfm

Where is social welfare maximised

MSC=MSB, Qso=Pso

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

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

When do positive production externalities occur

When Private costs (MPC) are greater than Social costs (MSC)

Model a positive production externality

Where is the free market equilibrium in positive production externalities

S=D, MPC=MPB, Pfm=Qfm

Where is social welfare maximised in a positive production externality

MSC=MSB, Pso=Qso

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

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.

Define externalities

third party spill over effect

Define government intervention

an action carried out by the government that affects the market with the objection of changing the free market equilibrium

Define market failure

 when the price mechanism fails to allocate scarce resources efficiently leading to a net social welfare loss

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

Define an indirect tax

tax levied on the producers of goods and services

model an ad velorem tax on a negative production externality

Model a direct tax on a negative production externality