The Economics of Pollution
Pollution is one of the most commonly used examples of negative
externalities. Read this text on the additional external costs (negative
externality) specific production processes create. Make sure you
understand that when a firm pollutes due to its production process, the
supply curve no longer represents all social costs.
Pollution as a Negative Externality
Pollution is a negative externality. Economists illustrate the social costs of production with a demand and supply diagram. The social costs include the private costs of production that a company incurs and the external costs of pollution that pass on to society. Figure 12.2 shows the demand and supply for manufacturing refrigerators. The demand curve (D) shows the quantity demanded at each price. The supply curve (Sprivate) shows the number of refrigerators that all firms in the industry supply at each price, assuming they are taking only their private costs into account and they are allowed to emit pollution at zero cost. The market equilibrium (E0), where quantity supplied equals quantity demanded, is at a price of $650 per refrigerator and a quantity of 45,000 refrigerators. Table 12.2 reflects this information in the first three columns.
Figure 12.2 Taking Social Costs into Account: A Supply Shift If the firm takes only its own costs of production into account, then its supply curve will be Sprivate, and the market equilibrium will occur at E0. Accounting for additional external costs of $100 for every unit produced, the firm's supply curve will be Ssocial. The new equilibrium will occur at E1.
| Price | Quantity Demanded | Quantity Supplied Before Considering Pollution Cost | Quantity Supplied after Considering Pollution Cost |
|---|---|---|---|
| $600 | 50,000 | 40,000 | 30,000 |
| $650 | 45,000 | 45,000 | 35,000 |
| $700 | 40,000 | 50,000 | 40,000 |
| $750 | 35,000 | 55,000 | 45,000 |
| $800 | 30,000 | 60,000 | 50,000 |
| $850 | 25,000 | 65,000 | 55,000 |
| $900 | 20,000 | 70,000 | 60,000 |
Table 12.2 A Supply Shift Caused by Pollution Costs
However, as a by-product of the metals, plastics, chemicals, and energy that refrigerator manufacturers use, some pollution is created. Let's say that if these pollutants were emitted into the air and water, they would create costs of $100 per refrigerator produced. These costs might occur because of adverse effects on human health, property values, or wildlife habitat, reduction of recreation possibilities, or because of other negative impacts. In a market with no anti-pollution restrictions, firms can dispose of certain wastes absolutely free. Now imagine that firms that produce refrigerators must factor in these external costs of pollution – that is, the firms have to consider not only labor and material costs but also the broader costs to society of harm to health and other costs caused by pollution. If the firm is required to pay $100 for the additional external costs of pollution each time it produces a refrigerator, production becomes more costly, and the entire supply curve shifts up by $100.
As Table 12.2 and Figure 12.2 illustrate, the firm will need to receive a price of $700 per refrigerator and produce a quantity of 40,000 – and the firm's new supply curve will be Ssocial. The new equilibrium will occur at E1. In short, taking the additional external costs of pollution into account results in a higher price, a lower quantity of production, and a lower quantity of pollution. The following Work It Out feature will walk you through an example, this time with musical accompaniment.
Source: OpenStax, https://openstax.org/books/principles-microeconomics-3e/pages/12-1-the-economics-of-pollution
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