Negative Externalities of Production Where the production of goods has spill over costs, the producers MC curve does not fully take account of the actual cost to society ECO 13/4/3

Negative Externalities of Production An example could be a chemical factory whose production results in the spread of chemicals in dust over adjacent farmland. This results in extra costs for the farmers who have to deal with the resulting damage to crops through extra watering.

Negative Externalities of Production This causes a loss of efficiency as the private equilibrium results in overproduction Over production results in output being produced where the social costs are greater than the social benefits, causing dead weight loss

Spill-over costs Negative Externalities of Production MC MB Pm Qm MSC The chemical producer considers their private cost and benefit and will produce Qm where MC=MB at a price of Pm. The spill over costs added to private costs give us the Marginal Social Cost curve MSC. Ps Qs When all the costs are taken into account the Socially Desirable outcome would be less production at Qs and a higher price to reflect the true costs Ps

Negative Externalities of Production MC MB Pm Qm MSC Ps Qs At Qm the MSC>MB which means production costs exceed the benefits of the production. DWL MSC > MB This results in a Dead Weight Loss for the economy This is shown as the area of excess costs resulting from the over production

Total Surplus At Qm Negative Externalities of Production MC MB Pm Qm MSC Ps Qs The total surplus at Qm is bigger than the total surplus at Qs giving a gain in efficiency As we have already seen the production at Qm results in spill-over costs Total Surplus At Qs As the spill-over costs exceed the gain in surplus there is a loss in efficiency, a Dead Weight Loss Spill-over costs DWL

Negative Externalities of Production MC MB Pm Qm MSC Ps Qs In order to achieve the socially desirable output and price the government could either; Fine the producers Put in place a pollution tax Regulate the producer to force them to clean up All of these will add to the private costs of the producer, resulting in the MC curve moving up giving the desired outcome

Negative Externalities of Production MC MB Pm Qm MSC Ps Qs The appropriate amount of tax or other cost placed on the producer is the vertical distance between MSC and MC at Qs MC+tax A common mistake is to measure the tax required at Qm, but this would result in too great a decrease in output, and another DWL The increase in the firms MC results in the market moving the socially desirable level of output, Qs, eliminating the DWL

Negative Externalities of Production MC MB Pm Qm MSC =MC+tax Ps Qs The tax also causes a decrease in total surplus The overall decrease in spill-over costs is greater than the loss in total surplus so that there is an efficiency gain, and the Dead Weight Loss is eliminated The tax decreases spillover costs Gain in efficiency

External Cost Negative Externalities of Production Internalising the Externality By making the costs of the firm increase to reflect the external costs, these spill over costs have become internal costs. Internal: Firms Private Costs

Negative Externalities of Production To be totally effective, a tax should be used to pay the costs of the pollution. The effected farmers should receive from the government money to reimburse them for their costs.