Question

a. Explain and describe the magnitude of the optimal production level of an item that has a negative externality (for example: pollution), if the company takes into account social costs. Compare this level of production with the level of production which only takes into account 'private costs' (private cost). b. What policy can be done by the government to reduce the production of goods that have negative externalities and encourage the production of goods that have positive externalities? Explain.

Answer 1

a. As shown in fig. below It shows negative externality of production. If we consider Only social costs then it means that social costs are much more than private costs. Qm is more than Qopt. Prices that market is paying is also lesser than optimum of Popt.

b.policy which can be done by the government to reduce the production of goods that have negative externalities and encourage the production of goods that have positive externalities:

Taxes: a negative externality of production means marginal social cost is more than marginal private cost. Production is more (Qm )than optimum (Opt).As shown in diagram tax imposed will shift supply to left with increase in price and social optimum Quantity is produced at Qopt. A tax imposed will shift Supply curve to left and optimum quantity can be produced.

Other policies can be: Tax on pollutants.This will make companies adopt less polluting technologies.

and tradable permits which will allow those companies to benefit which control pollution in control.