Calculating Welfare Changes from Externality Correction
A chemical factory's production process pollutes a river. The market price for its product is stable at $400 per ton. The factory operates at a privately optimal output of 80,000 tons per year, where its marginal private cost (MPC) equals the market price. However, the socially efficient output level, which accounts for the pollution damage, is 38,000 tons per year. At this efficient output, the marginal social cost (MSC) is $400. You are given the following additional information: At an output of 38,000 tons, the factory's MPC is $295. At an output of 80,000 tons, the MSC is $675. Assume both the MPC and MSC curves are linear. Based on this scenario, calculate the total net social gain from reducing production from 80,000 tons to 38,000 tons.
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Consider a market where production creates costs for society that are not paid by the producers. The graph for this market includes an upward-sloping Marginal Private Cost (MPC) curve and an upward-sloping Marginal Social Cost (MSC) curve, with the MSC curve positioned above the MPC curve. A constant market price is shown as a horizontal line. The unregulated market produces at Point A, where the price line intersects the MPC curve. The socially efficient production level is at Point B, where the price line intersects the MSC curve. Point C is the point on the MSC curve directly above Point A. Which of the following areas represents the total improvement in social welfare gained by reducing production from the inefficient market level to the efficient level?
In a negotiation between a town's residents and a local factory, the residents have full bargaining power. They can set the level of environmental quality the factory must adhere to, but the factory will shut down if it cannot make at least zero economic profit. Which outcome will the residents choose to maximize their own well-being?
Calculating Social Welfare Gains from Production Changes
In a market with a negative production externality, reducing output from the privately optimal level to the socially optimal level creates a net social gain because the producers' loss of profit is exactly equal to the reduction in external costs imposed on third parties.
In a market where production generates costs for a third party, output is reduced from the privately optimal level (where price equals marginal private cost) to the socially optimal level (where price equals marginal social cost). Match each economic concept related to this change with its corresponding graphical representation, defined over the range of output that is eliminated.
Explaining the Net Social Gain from Correcting an Externality
The Economic Rationale for Negotiated Solutions to Externalities
Bargaining Over a Negative Externality
Calculating Net Social Gain from Externality Reduction
Calculating Welfare Changes from Externality Correction