Consider the market for electricity. Suppose that a power plant dumps byproducts into a nearby river, creating a negative externality for those living downstream from the plant. Producing additional electricity imposes a constant per-unit external cost of $420. The following graph shows the demand (private value) curve and the supply (private cost) curve for electricity. Use the purple points (diamond symbol) to plot the social cost curve when the external cost is $420 per unit. ? PRICE (Dollars per unit of electricity) 1200 . 1080 900 840 720 600 480 360 240 120 0 0 1 3 2 4 QUANTITY (Units of electricity) The market equilibrium quantity is B Supply 6 (Private Cost). Demand (Private Value) Social Cost units of electricity, but the socially optimal quantity of electricity production is To create an incentive for the firm to produce the socially optimal quantity of electricity, the government could impose a unit of electricity. units. of $ per

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Market Failure Analysis

To understand Market failure, we need to first understand welfare economics. An Italian economist, Vilfredo Pareto stated that allocation of resources in an efficient manner such that an economic change, which harms no one and makes someone better off, indicates an increase in social welfare. It is also called Pareto Optimality, where resources cannot further be reallocated without harming one. This does not apply to those economic changes, which harm some and benefit others. social welfare increases if the utility of any of its members' increases and none decrease in the economy.