Question

Define the following and provide a graph illustrating the consequences e.g. under-production/consumption or over-production/consumption or deadweight loss of each in a perfectly competitive market. Explain the different approaches governments can use to bring about the socially efficient outcome.

(a) Negative Production Externality

(b) Negative Consumption Externality

(c) Positive Production Externality

(d) Positive Consumption Externality

Answer 1

a) Negative production externality- when production has an adverse effect on the third party is called negative production externality. In that case, the social cost is higher than private cost. So always there is overproduction in case of negative externality. The government can impose tax or quantitive restriction to bring socially efficient outcome.

b) Negative consumption externality- When consumption of one individual affect others is called negative consumption externality. In that case, the private benefit is more than social benefit. So there is always over consumption than the socially desirable amount. The government can increase the price or make some awareness campaign to bring socially efficient outcome.

c) Positive production externality- When the third party is benefited by the production of others is called positive production externality. In that case, private cost is higher than social cost so always there is under production. The government can give subsidy to the producer to bring socially efficient outcome.

d) Positive consumption externality- When the third party is benefited by the consumption of others is called positive consumption externality. In that case, social benefit is more than private benefit so there is always underconsumption. The government can decrease the price to boost the consumption and can bring socially efficient outcome.