Scribd
Upload
21 views1 page

A Polluting Firm Creates Market Failure by Producing Goods Without Accounting For The Environmental Damage

Polluting firms create market failure by ignoring environmental damage, leading to overproduction and low prices. Government intervention, such as imposing a tax equal to the external cost, can correct this by aligning private costs with social costs, resulting in reduced output and higher prices. This adjustment brings production closer to the socially optimal level and reduces pollution.

Uploaded by

mohammed9843
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
21 views1 page

A Polluting Firm Creates Market Failure by Producing Goods Without Accounting For The Environmental Damage

Polluting firms create market failure by ignoring environmental damage, leading to overproduction and low prices. Government intervention, such as imposing a tax equal to the external cost, can correct this by aligning private costs with social costs, resulting in reduced output and higher prices. This adjustment brings production closer to the socially optimal level and reduces pollution.

Uploaded by

mohammed9843
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 1

A polluting firm creates market failure by producing goods without

accounting for the environmental damage (a negative externality) it


causes. The firm only considers its private costs and not the wider social
costs to society, such as pollution. As a result, it overproduces and sells at
too low a price compared to what is socially optimal. Originally, the
market equilibrium is at output Q₁ and price P₁, where demand equals the
firm's private costs (MPC). However, the true socially efficient level would
be at a lower output and higher price, because the Marginal Social Cost
(MSC) is greater than the private cost.

To correct this market failure, the government can intervene by imposing


a tax equal to the external cost, shifting the firm’s supply curve upwards
from MPC to MSC. This leads to a new equilibrium at output Q₂ (lower than
Q₁) and price P₂ (higher than P₁), reducing the amount of pollution and
bringing production closer to the socially optimal level.

A power station burns coal to generate electricity, producing energy at low cost but releasing
harmful air pollution. The firm’s Marginal Private Cost (MPC) is lower than the Marginal
Social Cost (MSC) because it ignores the environmental damage. Consumers' Marginal
Private Benefit (MPB) equals the Marginal Social Benefit (MSB) as they enjoy electricity
without extra harm. The market produces too much electricity at quantity Q₁ and low-price
P₁, instead of the socially efficient quantity QE. Government intervention, such as a carbon
tax, raises the firm's costs, shifting MPC up to MSC. This reduces output to QE and increases
the price to P₂, correcting the market failure.

You might also like