Public Sector Economics
Natalie Karasová
755380
Winter semester
2014-10-27
In case of a negative externality (air pollution resulted from coal burning) what kind of government policies can be used (like tax, subsidy, quota) to achieve the social optimum. Explain why negative externalities are inefficient and need intervention, then critically analyse and compare these policies.
When the Pareto optimality allocation, an allocation when no one can be better off without making someone else worse off, is violated, the perfectly competitive market fails and it is said to generate a market failure. There are several types of market failure, which result in the loos of social welfare. One of the situations when market …show more content…
An externality is said to be present when the utility of an individual A depends not only upon the activities X that are exclusively under his control but also upon another activity Y, which is outside his control (Buchanan and Stubblebine, 1962). Externalities create a market price, which does not reflect all the costs, or benefits of the society. However, this inefficiency can be solved by government intervention. In terms of negative externalities the government can implement several policies in order to achieve the social optimum.
Externalities can take many forms. For policy purposes four more significant characteristics can be recognized. First to mention are pecuniary and technological externalities. Whereas pecuniary externalities operating through simple demand supply principle and do no require any government intervention, technological externalities are the exact opposite. Technological externalities directly affect consumers and producers and the market does not account them for. Equally important classification is whether the inefficiency arises from consumption (consumers externality) of production (producers externalities) activity closely …show more content…
The demand curve is the sum of all individual demand curves. At each quantity the demand shows the marginal value of electricity, the value of the last unit, which was consumed. The supply curve representing the marginal costs to the factory is called the private supply curve. The intersection of the marginal value and marginal costs is the competitive equilibrium. However, under the occurrence of externality (air pollution) this allocation does not account for the damages to consumers arising from coal burning. The right supply curve that takes the missed costs into consideration is called the social supply curve. The social supply curve reflects the marginal costs of producing electricity by coal burning for the whole society adding the aggregate marginal damage to the private marginal costs. Hence, in the market for electricity the optimal price and quantity is the intersection of the demand curve and social supply curve resulting in higher price and lower