Question

Background

Plastic packaging for products first became available in the 1950s, and its use has grown exponentially over the last 65 years. Over the past few years people around the world have become increasingly aware of the impact of plastic waste on the environment. Large quantities of plastic waste in waterways, discoveries of plastics ingested by sea animals and microplastics in the food web motivated many consumers to look more carefully at how their consumption contributes to plastic waste.

Over the last 12 months, the major supermarket chains have stopped offering “single use” plastic bags for customers’ groceries. However, these plastic bags are one small form of global plastic pollution. Plastic packaging exists on the bulk of consumer products. It facilitates transportation and reduces waste, by keeping the products free from damage, and, in the case of food products, reduces the risk of contamination and spoilage in the journey from manufacturer to the retailer’s shelf.

Question: Consider the production process for plastic packaged food. Carefully explain, with one or more suitable diagrams, how and why the market equilibrium for a plastic-packaged food product may deviate from the socially efficient equilibrium, and what form government intervention might take. You may assume that the market for food products, at the manufacturer level, is approximated by the perfectly competitive framework. Thanks!

Answer 1

Using plastic packaging imposes certain costs on the society. Ideally, producers should take this cost into consideration before deciding on how much final output they want to produce. However, producers don't- and this creates a negative externality. More specifically, the damage to the environment is an external cost because manufacturers of food products do not take these costs into account.

When evaluating the cost incurred for an additional unit of output, producers only take into account the private costs. Let PMC show the Private Marginal Cost curve. If there are no externalities, producers take all costs into account, and the cost they incur is the same as the cost that society incurs- in other words, Private Marginal Costs and Social Marginal Costs (SMC) are identical. However, when negative externalities exist, producers fail to take some cost (such as the cost to the environment from using plastic) into account in their production decisions. As a consequence, the product is more expensive for the society than it is for a firm. The SMC curve lies above the PMC curve.

You should know that the supply curve is just the marginal cost curve. The socially efficient output occurs where SMC intersects the demand curve. Here the demand curve is a horizontal line because the markets are perfectly competitive.

Firms will produce that output where PMC meets the demand curve. Notice that equilibrium output (Q₁) is higher than the socially efficient output level (Q₂).

Government can intervene in the market to solve this inefficiency. Recall that when the government imposes a tax on producers, the supply curve shifts up (that is, the PMC curve shifts up). If the government knows the PMC for a typical firm, and the SMC, the government can choose to impose an appropriate tax on producers. This tax will shift the PMC curve up, and if the tax is correctly chosen, the PMC will shift up till it intersects the SMC. This is called a Pigouvian tax. Now, the producers will take the cost imposed on the environment into account (as it equals the amount of tax that they have to pay) and produce the socially efficient amount of output.