Principles of Microeconomics / Unit 11 MIC 1004 worked example, 60 to 90 seconds
The Negative-Externality Market
The idea
From a demand schedule, a private supply schedule and an external cost per unit, build the social supply schedule by adding the external cost to the price at every private quantity. Find the market equilibrium, where demand meets private supply, and the socially optimal one, where demand meets social supply. The market quantity exceeds the optimum; the difference is the overproduction, and the market price is too low by less than the full external cost, because quantity adjusts too.
In practice
Worked example: the paint factory offers three, four and five thousand cans at forty, forty-five and fifty dollars, and buyers take five, four, three and two thousand at forty, forty-five, fifty and fifty-five. Demand meets private supply at forty-five dollars and four thousand cans. Adding ten dollars of river damage, social supply offers three thousand at fifty and four thousand at fifty-five, and demand meets it at fifty dollars and three thousand cans. The market makes a thousand cans too many, and its price is five dollars too low.
Where people slip
Add the external cost to the supply price at each quantity, which shifts supply up, not left along the quantity axis. And the optimum is not zero pollution; three thousand cans still do damage, and each of those cans is worth more to a buyer than its full cost.
Your place on the trail
Every lesson rests on earlier ones and opens later ones. Tap any to jump.
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