Sometimes market activities (production, buying, and selling) have unintended positive or negative effects outside the market's

scope. These are called externalities. As a policy maker concerned with correcting the effects of gases and particulates emitted by and local power plant, answer the following questions: 1. What two policies could you use to reduce the total amount of emissions? Answer: The two policies used to reduce the total amount of emissions are:1) A pollution tax. 2) Regulation by government that sets a cap on the amount of pollution that can be emitted. Generally, a negative externality arises when private costs incurred by the decision maker is less than the social costs of an activity.. When this occurs the amount emitted is set at a point where private marginal cost equals private marginal benefit. The local company emits too much and market imperfection takes place since the private marginal costs are less than social marginal costs. The main objective is to provide local firm in choosing the social optimal amount of emissions. Hence, any solution from decision maker internalize the externality which fixes the problem 2. Pollution tax It can solve the problem. A tax on the local firms output would be required. The size would be set equal to negative externality size created by each unit produced. Suppose, if each unit created 10 units of emissions and each unit causes $0.10 harm to community, then $0.10*10 = $1 per unit tax would be charge from the local firm. This is known as corrective tax. With this tax social marginal cost is equal to private marginal cost curve and local firm will select the socially optimal amount of emissions. Regulation that restricts number of units of emissions An alternative is to penalize the local firm with a high sanction if the emission is higher than the amount, when the socially optimal amount of pollution is identified. Any amount of emissions can be achieved from this strategy as threatened sanction is enough and enforcing the regulatory standard is done sufficiently.

3. *What would the benefits of each action be (besides emissions reduction)?" Solution: Negative Externalities: When the action of one party imposes cost on another party it is called as negative externalities. For example when a steel plant dumps its waste in a river that fisherman downstream depends on for their daily catch. The more waste the steel plants dump in the river the fewer fish will be supported Positive Externalities: Positive externalities occur when a home owner repaints his house and plants an attractive garden. All the neighbors benefits from this activity, yet the home owners decisions to repaint and landscape probably did not take these benefits into account.
In the given fig. the horizontal axis measures the home owners investment in repairs and landscaping. The marginal cost curve for home repair shows the cost of repair as more work is done on the house, it is horizontal because the cost is unaffected by the amount of repairs. The demand curve D measures the marginal private benefit of the repair to the home owner. The home owner will choose to invest q in repairs at the intersection of her demand and marginal cost curve. But repairs generate external benefits to the neighbors, as the marginal external benefit curve, MEB, shows. Value MSB

MC

MEB

.q1

Repair level