Question

We see externalities exist in the market because marginal social benefit does not equal marginal social costs. A common example of an externality is pollution. Do you think firms evaluate the cost of pollution and still produce the good even if it results in pollution?

Answer 1

Nevertheless, the situation isn't really that easy. Pollution is produced as a by-product of the metals, plastics, chemicals and energy used in the manufacture of refrigerators. Let's say they would generate costs of $100 per refrigerator created if these contaminants were released into the air and water. Such costs may arise due to human health accidents, effects on property values, loss of wildlife habitat, reduction of leisure opportunities, or other negative impacts.

Economists commonly refer to externalities as an example of market failure since externalities represent a situation where markets no longer consider all social costs but only some of them. In the event of a market failure, the private market fails to achieve productive production because either corporation does not take into account all costs incurred in generating product and/or customers do not take into account all benefits gained in the event of a positive externality. In the case of pollution, the social cost of production at the market level exceeds the social benefits for consumers, and the industry produces too much of the commodity.

The supply curve will no longer represent all social costs when the externality of emissions occurs. Economists commonly refer to externalities as an example of market failure because externalities represent a situation where markets no longer consider all social costs, but only some of them. When a market failure occurs, the private market fails to achieve productive production because either corporation does not take into account all costs incurred in generating product and/or customers do not take into account all the benefits (a positive externality) gained. In the case of emissions, environmental production costs outweigh social benefits for consumers at market price, and the industry produces too much of the commodity