Question

Externalities

1) Amanda owns an electric power plant in the city of Wetaskiwin. Francesca owns a laundry service next door to the power plant. Francesca's specialty in town is the “spring fresh” scent he achieves by air-drying laundry outside. In producing electricity, Amanda also produces smoke. Unfortunately, Amanda’s smoke dirties Francesca’s laundry, creating costs for Francesca of for each kwh Amanda produces.

(a) Draw a figure, with lines indicating the private and social cost to supply electricity as well as the private and social marginal benefit of producing electricity

(b) In your figure, shade in the social cost to society (total social and private costs) from producing the market equilibrium quantity of electricity.

(c) Suggest some possible solutions for this market failure.

Answer 1

In this case, since the market outcome is inefficient, market failure results (due to the presence of negative externalities).