Question

1.Give an example of negative production externality in which government gives the property rights to the group that is hurt. How does this mechanism solve the problem? DO NOT use any of the examples from the book or given in the class!

2. Using the same example you came up above, carefully explain what happens if government gives the property rights to the producer. How does this mechanism solve the problem?

Answer 1

1. Negative externality means when action of an individual affects negatively others who does not pay for it. Suppose that there is a steel factory which dumps the waste of its production process into the river. An other persons who depends on rivers for his survival by fishing. It creates negative externality to the fisher man. The factory produces an output level of Q where demand curve and supply curve intersects. at price level P . Its price greater than marginal cost. But its price is equal to social marginal costs. Market prices do not reflect social costs. Suppose the government give the property rights to the fisherman who is being negatively affected by dumping wastes into river. So now, the factory owner has to pay a certain amount of money to the fisherman to produce each output. The benefit that received by fisherman from the factory owner must be greater than loss of fisher man when factory man dumps its waste in to river. Therefore . factory owner has to pay a certain amount of money for producing each additional unit of output. So his cost will increase and he try to reduce output to reduce his cost. Now his price reflects the marginal costs of factory His price will increase to P* and output reduced into Q* Suppose the government has give property rights to factory owner. He will produce as much as want and dump wastes into river beyond factory. But it affects livelihood of fisher who depends on river for fishing as his survival. So the fisherman ready to give a certain amount of money to the factory owner that will be greater than losses incurred by the factory owner ,if he reduces his output to Q* at price level P*. Negative externality can internalize by providing property rights to the victim or creator of negative externality