11.1 The Economics of Pollution
Learning Objectives
By the end of this section, you will be able to:
- Explain and give examples of positive and negative externalities
- Identify equilibrium price and quantity
- Evaluate how firms can contribute to market failure
Externalities
Private markets, such as the cell phone industry, offer an efficient way to put buyers and sellers together and determine what goods they produce, how they produce them, and who gets them. The principle that voluntary exchange benefits both buyers and sellers is a fundamental building block of the economic way of thinking. However, what happens when a voluntary exchange affects a third party who is neither the buyer nor the seller?
As an example, consider a concert producer who wants to build an outdoor arena that will host country music concerts a half-mile from your neighborhood. You will be able to hear these outdoor concerts while sitting on your back porch—or perhaps even in your dining room. In this case, the sellers and buyers of concert tickets may both be quite satisfied with their voluntary exchange, but you have no voice in their market transaction. The effect of a market exchange on a third party who is outside or “external” to the exchange is called an externality. As externalities that occur in market transactions can affect other parties beyond those involved, they are sometimes called spillovers.
Externalities can be negative or positive. If you love country music, then what amounts to a series of free concerts would be a positive externality.
Pollution as a Negative Externality
Pollution is a negative externality. Economists illustrate the social costs of production with a demand and supply diagram. The social costs include the private costs of production that a company incurs and the external costs of pollution that pass on to society. Figure 11.2 shows the demand and supply for manufacturing refrigerators. The demand curve (D) shows the quantity demanded at each price. The supply curve (Sprivate) shows the quantity of refrigerators that all firms in the industry supply at each price assuming they are taking only their private costs into account and they are allowed to emit pollution at zero cost. The market equilibrium (E0), where quantity supplied equals quantity demanded, is at a price of $650 per refrigerator and a quantity of 45,000 refrigerators. Table 11.2 reflects this information in the first three columns.
|
Price |
Quantity Demanded |
Quantity Supplied before Considering Pollution Cost |
Quantity Supplied after Considering Pollution Cost |
|
$600 |
50,000 |
40,000 |
30,000 |
|
$650 |
45,000 |
45,000 |
35,000 |
|
$700 |
40,000 |
50,000 |
40,000 |
|
$750 |
35,000 |
55,000 |
45,000 |
|
$800 |
30,000 |
60,000 |
50,000 |
|
$850 |
25,000 |
65,000 |
55,000 |
|
$900 |
20,000 |
70,000 |
60,000 |
However, as a by-product of the metals, plastics, chemicals and energy that refrigerator manufacturers use, some pollution is created. Let’s say that, if these