Mr. Weiss

Section 14 – Module 75 Activity – Negative ExternaltiesSection 14 – Module 75 Activity – Negative Externalties

A company has decided to locate its A company has decided to locate its new textbook manufacturing plant new textbook manufacturing plant on the local river. Effluent from the on the local river. Effluent from the production process is release into production process is release into the river. When questioned about the river. When questioned about this practice, the company this practice, the company responded that it is cheaper to responded that it is cheaper to release waste into the river than to release waste into the river than to have it hauled away. In the weeks have it hauled away. In the weeks that followed, much discussion took that followed, much discussion took place and eventually the local place and eventually the local authorities decided to impose a $25 authorities decided to impose a $25 per unit tax on this company.per unit tax on this company.The following graph shows the The following graph shows the private cost and private benefits of private cost and private benefits of the plant.the plant.

Mr. Weiss

Section 14 – Module 75 Activity – Negative ExternaltiesSection 14 – Module 75 Activity – Negative Externalties

1.1. Identify the equilibrium Identify the equilibrium price and quantity for price and quantity for textbooks from the textbooks from the plant.plant.

2. Calculate the new 2. Calculate the new supply (with the supply (with the imposition of the tax) imposition of the tax) and plot it on the graph.and plot it on the graph.

3. Identify the new 3. Identify the new quantity demanded.quantity demanded.

Mr. Weiss

Section 14 – Module 75 Activity – Negative ExternaltiesSection 14 – Module 75 Activity – Negative Externalties

Answers for Questions 1, 2 Answers for Questions 1, 2 & 3:& 3:

S2

Q1Q2

S1

P2

P1

Quantity Quantity moves from moves from

Q1 to Q2 and Q1 to Q2 and Price moves Price moves from P1 to from P1 to

P2.P2.

Mr. Weiss

Section 14 – Module 75 Activity – Negative ExternaltiesSection 14 – Module 75 Activity – Negative Externalties

Questions 4, 5, 6 & 7:Questions 4, 5, 6 & 7:

4. If it is true that the original supply curve depicts the private cost 4. If it is true that the original supply curve depicts the private cost of producing textbooks given the ability to release effluent into the of producing textbooks given the ability to release effluent into the river, and that the new supply curve (including the tax) depicts the river, and that the new supply curve (including the tax) depicts the social cost of producing textbooks, what cost do people not social cost of producing textbooks, what cost do people not associated with the production of consumption of textbooks pay associated with the production of consumption of textbooks pay per textbook produced?per textbook produced?

5. What is the resource allocation problem associated with the 5. What is the resource allocation problem associated with the presence of significant negative externalities?presence of significant negative externalities?

6. Explain one market-based solution that would correct for this 6. Explain one market-based solution that would correct for this misallocation or resources.misallocation or resources.

7. What are some other examples of activities that create negative 7. What are some other examples of activities that create negative externalities? How would you suggest that we correct for the externalities? How would you suggest that we correct for the resulting market failure?resulting market failure?

Mr. Weiss

Section 14 – Module 75 Activity – Negative ExternaltiesSection 14 – Module 75 Activity – Negative Externalties

Answers for Questions 4, 5, 6 Answers for Questions 4, 5, 6 & 7:& 7:

4. Those who are neither consumers nor producers of textbooks are 4. Those who are neither consumers nor producers of textbooks are forced to pay some of the costs associated with the production of forced to pay some of the costs associated with the production of these goods. In this case, those costs come in the form of a these goods. In this case, those costs come in the form of a degraded environment and amount to $25 per textbook.degraded environment and amount to $25 per textbook.

5. Goods for which there are significant negative externalities are 5. Goods for which there are significant negative externalities are overproduced by the market.overproduced by the market.

6. The tax is one solution that brings the producer to internalize 6. The tax is one solution that brings the producer to internalize the cost of being paid by society. Some people argue that the the cost of being paid by society. Some people argue that the privatization of the river would be another solution, although that privatization of the river would be another solution, although that might be hard to accomplish.might be hard to accomplish.

7. Answers may include smoking, driving, playing loud music, 7. Answers may include smoking, driving, playing loud music, manufacturing and littering.manufacturing and littering.