In the problem and increase economic efficiency. This

In economics, market efficiency
occur when the maximum amount of goods and services are produced with a limited
level resources, provided that no additional output can be produced without
increasing amount of input. Efficient market is pareto efficient where the
price is equal to the marginal social cost. In some markets, buyer and sellers
have influence in the control of market prices. This is known as market power.
Stability of supply and demand can be affected by market power and cause
inefficiency in market as it controls the the price and quantity. When a
circumstance where the price mechanism leads to inefficient allocation of the
resources and cause a deadweight loss of economic welfare is known as market
failure. There are many causes of market failure; including monopoly power,
negative externalities, imperfect information and public goods. When market
fails, government and public policy can interfere to potentially remedy the
problem and increase economic efficiency. This essay will explore the negative
external effects as a cause of market failure, the welfare losses that occurs
and government intervention to address the market failure.

According to Core
Econ textbook, external effects are defined as ‘a positive or negative effects
of a production,consumption, or other economic decision on another person or
people that  is not specified  as a benefit or liability in a contract’.
Therefore a negative externalities is an external cost suffered by a third
party as a result of a transaction. Producer and consumer are regarded as  the first and second parties in an economic
transaction. The third parties are any individual, organisation, property owner
or resources that are directly affected by actions of consumer and producers
attempting to pursue their own self interest. According to Adam Smith as
explained in his book “An Inquiry into the Nature and Causes of Wealth of
Nations” , selfishness leads markets to produce whatever people want, to gain
profit, to get rich, you have to sell what public is eager to buy. (Caplan)The selfishness of producers and consumers cause negative
externality can cause the marginal social cost to exceed the marginal private
cost.

The graph above shows 
the effect of negative externality. Without considering externality the
quantity is at Q1 which is the pareto efficient quantity of goods produced as
the marginal social cost and the marginal social benefit is equal. When there
is a negative externality, there is an external cost because the producers do
not take responsibility for the external cost, the cost is beared by the
society. Thus the supply curve is effectively shifted to the right because the
producers have lower marginal cost.Now that the supply curve has increased,
more goods are produced than the efficient amount, the good produced with
negative externality is Q. Since marginal social benefit and marginal social
cost are not in equilibrium there is a deadweight loss. The firms producing
goods at Q which is more than the socially efficient quantity Q1 is what causes
the market failure.

Negative externalities happen when social cost exceed the
private cost of goods. Marginal social cost is defined as “the cost of
producing an additional unit of a good taking into account both the cost for
the producer and the cost incurred by others affected by good’s production”. (Project) Thus marginal social
cost is essentially the sum of the marginal private cost and marginal external
cost.

 The red area in the
above graph shows the deadweight loss or net welfare loss due to market output
supplied is greater than the social optimum. Net welfare loss exist in two
situations. First, it exist when the marginal cost to society is greater than
the marginal benefit of a particular economic activity to society. Secondly, if
the marginal benefit is greater than marginal social cost. (Negative
Externalities, n.d.) In the case of negative externality
refers to the first situation as the market over produce goods that generate
external cost. Any output between Q1 and Q creates a net welfare loss because
of external cost or pollutions emitted.

As explained above, negative externalities occur when third
parties outside the market are affected by production or consumption for which
no compensation is paid. Most common example of negative externality is
pollution. For example, the harmful effect of passive smoking on non smokers
(third parties) by smokers which may cause health problems and increased
spending on medical bills. Furthermore, the noise pollutions neighbours have to
face when music is turned on loudly which causes disturbance to community. These
negative consumption externalities leads to social benefit is less than private
benefits. Externalities also occur when there is no allocation on property
rights over assets and resources, or not predetermined thus uncertain. For
example the ocean, the air that we breathe are not private property of any
individual. There is no ownership and rights allocated to them, so ships can
pollute the ocean without being afraid of being sued in court, Air pollution
from traffic congestion do not take into account the harmful effects to people
inhaling the air, leading to prolonged illness such as lung diseases. (Alvi, 2017).

Negative externalities in goods or services cause the entire
market fails to operate effectively. This is because the cost inflicted to
other people that failed to be taken into account by individuals who incur the
cost and the way their actions are affecting and impacting others. Government,
due to ownership of industries, has power to prohibit the products and their
related activities that causes negative externalities. However, there are
situations where externalities may not even be corrected because positive and
negative externalities are related to each other. For example, mowing lawn is a
n act of grooming appearance of household is 
a positive externality but the noise of the lawn mower gives a loud
nuisance noise to your ears which is a negative externality.

On negative production externalities, governments can impose
large fines and restrict the amount of pollution being dumped. There are
pollution permits by the Emission Trading Scheme(ETS) that can be bought and
sold in order to put some financial pressure on the firms emitting pollution
and causing negative externalities. Government could also grant property rights
as pollutions in the environment happens because there are no property rights.
According to Ronald Coase in his Coase theorem, allocating property rights will
encourage the appointed owners to protect the resources by allowing them to sue
who exploit the resources (Lack of property rights, n.d.). For instance, the
National River Authority which is now a part of Environment Agency was given
powers to act ‘as if’ it owned the UK’s rivers. This allowed them to police the
rivers and sue the polluters of rivers and illegal poachers.

Negative consumption externalities can be prevented by
government intervention by imposing regulations, levying tax and using
information and nudge theory. Regulation and Laws can be implemented to reduce
negative externality in a market. The Health and Safety at Work covers all
businesses. A ban on smoking in public places was placed by the British
Government in 2007 was in effort to reduce the effect of smoking on passive
smokers.(Health Act 2006,s.28) Prohibition of public consumption of alcohol and
noisy unruly neighbours can be taken action by Local Councils as they can pass
bye-laws. Information and nudge theory can be enforced by the government by
putting warning on cigarette’s packets to discourage people from smoking. Corrective
tax can be imposed to make consumers pay full social cost of the goods.
Therefore reducing consumption and create a more socially efficient outcome.
Negative externality, if not corrected will cause overconsumption because they
ignore the external cost. Goods equal to external marginal cost should have a
tax placed. Thus, consumers will end up paying the full social marginal cost.
As shown in the graph below, after tax is imposed, the quantity of output falls
from Q1 to Q2 because the price is increased 
with tax price. This situation is considered socially efficient because
Social Marginal Cost(SMC) is equal to Social Marginal Benefit (SMB). (Tax on
Negative Externality , n.d.)

Related Posts

© All Right Reserved