Caose Theorem

1164 Words Sep 17th, 2013 5 Pages

(a) Explain what is meant by “externalities”? (b) Consider an industry whose production process emit a gaseous pollutant into the atmosphere. Use the simple supply and demand model to demonstrate that, in the absence of any regulation, this industry’s production will result in allocative inefficiency in the use of society’s resources. Externalities is cost or benefit from production or consumption of commodity that flow to external parties but not taken into account by market (Bajada, 2012). The impact of externalities is the distortion in allocation of resources. Externalities will cause individual to pursuit based on their self-interest. Hence, it will cause
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The market equilibrium that reflect social cost should be at the price that higher than Pp and the quantity is lower than Qp. | Point (c) and (d) below will explain more about the correction should be taken to overcome externalities cost. (2) Externalities Benefit
Externalities benefit is production or consumption of commodities that confer benefit, for which payment or compensation is not required, on third parties or community at large (Bajada, 2012). When externalities benefits occur, the market demand curve reflects only the marginal private benefit, this will understate the marginal social benefits available to the society thus the commodity become undervalued and undersupplied (Bajada, 2012)
The example of externalities benefit is education. Higher education not only benefit for individual related to higher income, but also benefit for community such as more educated community and tolerant citizen. Source: | The curve shows that the market equilibrium at price Pp and Quantity Qp. Nevertheless, the market did not include the social benefit of education for the communities. Hence, the market price is underpriced. Furthermore, it also causes under-allocation of education by producers. |
There are several corrections by government to make the market reflect the social benefit, which are: (1) Subsidized the supply, so that the supplier