Chapter 5, Problem 2CTQ

To determine

The problems faced by China in determining the right amount of water pollution to permit.

Concept Introduction:

Externality- A market exchange or economic activity where a third party or a person external to the exchange (rest of the society) is affected and bears the cost or gets the benefit from it is called an externality. An externality is of two types-positive and negative.

Negative Externality- The externality is negative if the cost of a market transaction is shifted from the private market to the society. Examples - Pollution, congestion etc.

Positive externality- The externality is positive if the benefit of a market transaction is shifted from the private market to the society. Example-Education, immunization programs etc

External Cost- The additional cost incurred by the third party outside the production process when a unit of output is produced.

External Benefit- The additional benefit enjoyed by the third party outside the production process when a unit of output is produced.

Over-allocation of resources- Production of more than the optimum level of output implies that the resources are over-allocated.

Under-allocation of resources-Production of less than the socially optimum level of output implies that resources are under-allocated.