Question

When is banning the use of something or a certain activity likely to achieve a socially efficient outcome?

Explain three reasons why Economist prefer market-based solutions to externalities rather than command and control using diagrams.

List six solutions to externalities. Indicate which are "private solutions" and which are government "market-based" solutions

Answer 1

A socially efficient outcome captures the optimal distribution of resurces in the society. It takes into account all external costs and benefits, as well as all internal costs and benefits. Socially efficient equilibrium occurs where marginal social cost is equal to marginal social benefit.

Sometimes, to achieve a socially effeicient outcome, banning the use of or certain activity become important. Consider the case of tobacco and tobacco producing industries. Tobacco has its own demand curve and supply curve which produce price equilibrium. But, tobacco has an adverse effect on the health of the cosumers. Also, pollution caused by tobacco producing industries effect the environment of nearby areas which gradually effect the health of the individuals residing in the vicinity. Another ripple harmful effect is of passive smoking.

Now, considering all these social costs attached to this industry, the supply function should also factor in these social costs. The focus should be on reducing the social costs by following measures such as banning/regulating the consumption of tobacco in public places, having stricter environmental laws, etc. Thus, regulation of this industry by the government would lead to reduction in social costs and thus lead to a more socially efficient outcome.