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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.

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. What is meant by the tragedy of the commons?

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 landfill tax?

8. Why might pollution taxes not be effective?

9. Draw a diagram to show the possible effects of a carbon tax.