Negative Externality of Production: The unintended side effects result from production Society face the negative spill over cost resulting from firms’ production. In New Zealand, an example of negative externality of production is cutting down native trees. Cutting down native trees will cause events such as erosion, flooding and landslides, which are the negative spill over cost. Negative externality of production can be represented in the graph below: In New Zealand, an example of negative externality of production is cutting down native trees. Cutting down native trees will cause events such as erosion, flooding and landslides, which are the negative spill over cost. Negative externality of production can be represented in the graph below: Society faces negative spill over cost when Government uses taxpayers money to repair damages result from landslides, flooding and erosion.

PMB = SMB Output Cost/Revenue P FM SMC QSQS Q FM PSPS Total Gain from Trading (TGT) unable to cover entire spill over cost so create dead weight loss (DWL). It can be shown in the graph below: Negative Spill over Cost Producers’ Surplus (at Free Market) Total Gain from Trading (TGT) Consumers’ Surplus (at Free Market) Consumers’ Surplus (at Social Equilibrium) PMC Producers’ Surplus (at Social Equilibrium before Government intervention) Social Equilibrium Graph : Negative Externality of Cutting Down Native Trees

Market for Timber Price Dead weight loss could be eliminated when Government intervenes the free market. There are two fiscal policies the Government could implement. They are imposing sales tax on timber and introduce the Resource Management Act (RMA). Effectiveness of Imposing Sales Tax on timber: On consumers:  Increase the price consumers need to pay from P to P CON = P 1  Makes timber relatively less affordable  Decrease quantity demand from Q to Q 1 On producers:  Decrease the price producers receive from P to P PR  Decrease producers profitability level  Producers cut down less native trees (cut production)  Decrease quantity supply from Q to Q 1 Decrease quantity demand and decrease quantity supply bring market back to social equilibrium (P CON = P 1 = Q 1 ) and so the DWL is eliminated Quantity D S TAX (=SMC) S (=PMC) P Q P CON = P 1 P PR Q1Q1

Equity of Imposing Sales Tax on Timber: On consumers:  It will mainly affect low income earners the high income earners  Decrease the purchasing power of the low income earners as they now need to spend a greater portion of their income to buy the timber they desire  Therefore imposing tax on timber is not vertically equitable On producers:  It will affect all producers cutting down native trees  Producers with good practices need to pay same amount of tax to the Government as those producers who are not using good practices  Therefore imposing tax on timber is not horizontally equitable Based on these, it shows that imposing sales tax is neither horizontally equitable nor vertically equitable policy

Effectiveness of Introducing RMA: On producers:  Producers restricted from using the land  Producers to apply resource consent from Government  Producers to show their ability of implementing good practices, sustain the land and pay a fee to Government  Increase producers cost of production from P to P 1  Decrease producers profitability level  Producers cut down less native trees (i.e. cut production)  It causes the supply to decrease from S (=PMC) to S 1 (=SMC=PMC 1 )  Market operating at social equilibrium (SMC = SMB)  Eliminates DWL (i.e. market allocating resources efficiently) Resource Management Act (RMA) regulates access to natural and physical resources such as land, air and water with sustainable use of these being the overriding goal. Market for Timber Price Quantity D (=PMB=SMB) S 1 (=SMC=PMC 1 ) S (=PMC) P Q (Q FM ) P S = P 1 Q 1 (Q S )

Equity of Introducing RMA: On consumers:  It will mainly affect low income earners the high income earners  Consumers bid timber price up to secure the timber they desire  Decrease the purchasing power of the low income earners as they now need to spend a greater portion of their income to buy the timber they desire  Therefore introduction RMA is not vertically equitable On producers:  It will mainly affect those producers (cutting down native trees) who do not have good practices  Producers without good practices will be review and declined by Government at worst when applying for resource consent (i.e. tougher assessment and more restrictions from Government)  Those producers with good practices will have less impact from RMA  Producers able to get consent easier as they are already obeying the regulations set in RMA  Therefore introducing RMA is horizontally equitable Based on these, it shows that introducing RMA is horizontally equitable but not vertically equitable policy

QSQS Q FM PMB = SMB Cost/Revenue P FM SMC PSPS Negative Spill over Cost Consumers’ Surplus (at Social Equilibrium) PMC Producers’ Surplus (at Social Equilibrium before Government intervention) Social Equilibrium Producers’ Surplus (at Social Equilibrium after Government intervention) After Government intervention (i.e. imposing sales tax on timber & introducing RMA), DWL will be eliminated and it can be shown in the graph below. Government intervention brings the market back to equilibrium (new social equilibrium): Graph : DWL been eliminated after Government intervention

I would recommend the Government to introduce RMA Because:  RMA is relatively more equitable policy (i.e. horizontally equitable but not vertically equitable) than imposing sales tax  RMA will restrict producers with bad practices from using the land to cut down native trees.  It protect land for the future and not imposing any addition cost on consumers in the short term I would recommend the Government to introduce RMA Because:  RMA is relatively more equitable policy (i.e. horizontally equitable but not vertically equitable) than imposing sales tax  RMA will restrict producers with bad practices from using the land to cut down native trees.  It protect land for the future and not imposing any addition cost on consumers in the short term I would not recommend the Government to impose sales tax on timber Because:  It is not equitable policy (i.e. neither horizontally equitable nor vertically equitable) as it affect both low income earners as well as producers with good practices I would not recommend the Government to impose sales tax on timber Because:  It is not equitable policy (i.e. neither horizontally equitable nor vertically equitable) as it affect both low income earners as well as producers with good practices Therefore introducing RMA would be a better policy to be implemented than imposing sales tax on timber

!THANK YOU! BY: SHAUN YOON (13 BRC) FOR: 13 ECONOMICS UNIT STANDARD 10928