Externalities

Question 1

A steel manufacturer is located close to a large town. During production it emits sulphur which creates an external cost to the local community. The private costs of production and the private benefits to steel buyers, who are mainly cars producers, are shown, along with the estimated external costs.

Quantity of Steel (m tonnes)	Price car makers are prepared to pay, based on expected private benefit (£)	Price steel makers are prepared to receive, based on their private production costs (£)	Estimated external costs to society of pollution  (£)
1	10000	1000	1000
2	9500	2000	1500
3	9000	3000	2000
4	8500	4000	2500
5	8000	5000	3000
6	7500	6000	3500
7	7000	7000	4000
8	6500	8000	4500
9	6000	9000	5000

1. Draw a graph to show market price and quantity and plot the effects of including external costs. Show the socially efficient output of steel. 

2. Show the area of net welfare loss on your graph.

3. What remedies could the authorities employ to deal with the problem of external costs?

Question 2

Short questions

1. Why is the planet increasingly polluted?

2. Draw a graph to show a negative production externality.

3. On this graph, show the 'net welfare loss'.

4. Explain how permits to pollute work.

5. What is carbon trading?

6. What is carbon offsetting?

7. What is a 'rubbish tax'?

8. Why might pollution taxes not work very well?

9. Draw a diagram to show the effect of a carbon tax.

Further research - find out about Electronic Road Pricing (ERP) in Singapore.