Negative Externalities Of Production Essay

The article raises the issue of negative externality of production caused in China, by the pollution produced by the factories in the country. This is a case of market failure, which is due to the inefficient allocation of resources in an economy and as a result, there occurs welfare loss, due to which the society is at the stake. Further, “the negative externalities of production occurs when any production activity impose external costs on the third party outside of the market for which no appropriate compensation is paid”.

Diagram 1

Diagram 1, shows the negative externalities of production. There are two cost curves shown, MSC (Marginal Social Cost) and the MPC(Marginal Private Cost) which is the cost of production of the firm.

Among these measures, the government either goes for regulations against the polluting firms or the government goes for market based policies. Using market based policies; government either issues tradable permits to the polluting firms or raises the tax on per unit of output produced by the polluting firm.

Diagram 2

The diagram 2 above shows the tradable permits which the government allows to the polluting firms. “Tradable permits are environmental regulatory scheme where the sources of the pollutants are regulated by the government”. The supply curve S, shows that the supply of trade permits is perfectly inelastic and initially the demand of the permit is D1 at the price P1. But with the growing economy, it is necessary for the firms to produce, therefore the demand of the permits increase. Since the supply is inelastic, the price will also rise in the same proportion, thereby the firms is forced to reduces its pollution in order to avoid its expenses made to buy these permits.

The other way, the government can force the firm to reduce its pollution emission is by increasing the marginal private cost of the producer to the level of marginal social cost. This is done by charging the tax by the firm on its output.

Diagram