A market failure occurs when the allocation of good is not efficient. The externality is present if an economic activity (production or consumption) imposes costs on, or creates benefits for, third parties. If they impose costs on third parties they are considered negative externalities. Negative externality is a type of market failure. The government in London decided to impose tax on hauliers who use trucks that heavily polluted the environment. This is a negative externality since pollutions would hurt citizens in London. [pic]
Figure 1 shows the negative externalities of using heavily polluting truck in London. Marginal private costs are the costs of producing an extra unit of out put. Marginal social costs are the costs of producing an extra unit of output that are borne by society. Marginal private benefits are the benefits the individual enjoys from the consumption of an extra unit of a good. Marginal social benefits are benefits that society enjoys from each extra unit consumed. MPB of buyers is identical to MSB as no external effects in the consumption of truck are assumed. Since using tucks entails external costs in the form of pollution, it follows that society loses in the use of truck more than the firms consider. Therefore, MSC of truck production are bigger than the MPC. Refer to the Figure 1. The market will lead to Q units of truck service at a market price of P per unit. The socially optimal level of using truck is less at Q2 since the MSB are equal to the MSC. From society’s view units Q2 should not have been produced. There is overproduction of truck service, which is the market failure. Area (efh) represents the welfare loss as a result of the pollution. [pic] [pic]
The London government uses the method of indirect taxation to solve this problem. It imposes a tax on those hauliers for 200 pounds a day for every heavily polluting truck that enters London. The government estimates the pollution costs the...
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