Question

The following question refers to pareto effciency

(a) Explain why in the absence of externalities voluntary trades must be Pareto improving .

(b)Explain why voluntary trades may not be pareto improving if externalities are present.

(c) Give examples of positive and negative externalities and explain your examples. Explain in each

case how the market and effcient allocations will differ.

Answer 1

Solution:

a)

Absence of the externality voluntary trade must be Pareto improving:
The Pareto efficiency stares that when reallocation occurs someone will better off without making other worse off But the externality makes some one worse off Since, from the voluntary trade two parties are better off The absence of the externality positively affect the two party activity, we can say that the voluntary trade must be Pare. improving

b)
With the externality voluntary trade must be Pareto not improving:
The externality results someone worse off from the activity Pareto aims that, without worse off someone the society will be betra-off Externality is the pubfic aim activity and it affect the voluntary trade also affect the third party

c)
Positive externality:
The externality an from the consumption of goods and services The positive externality occurs when the third party benefit from the consumption of goods and services
The example of the positive externality is public roads, public canals, street lights etc
Negative externality:
The negative externality is that cost blamed by the party due to the third party activity
Smoking is the example of the negative externality. As we know that smoking is injurious to healt if someone smokes in public place it affects the other people's health condition which create additional cost for the treatment
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