Name a good with a negative externality associated with it, and explain the exte

Question

Name a good with a negative externality associated with it, and explain the externality.

ii) Does this good have an elastic or inelastic demand? What about its supply? Explain.

iii) What two goals can be accomplished by taxing this good? How does the elasticity of the

good help to determine the effectiveness of the tax for accomplishing these goals?

iv) Which side of the market will be hurt more by a tax, the producers or the consumers? Why?

(If you think they will be hurt equally, say so and justify).

v) What is another policy option for achieving at least one of the goals listed in (iii)? Discuss its

pros and cons when compared to taxation.

Explanation / Answer

1.Externality implies to the benefit or cost suffered by the third party. Usually, the third party is considered society. The more of a commodity is produced, the more an externality occurs. It can be positive as well as negative. Both the externalities affect the market sector of that commodity consumed or produced. For example: a firm producing chemicals that emits air pollutants, in other words, causes pollution. Due to which, a nearby lake also get polluted, which makes all the aquatic animals, like fish die. This is a loss for all the fishermen, resulting in loss of their income. This will be a negative externality.

2. Such chemicals will affect the demand and supply in the market causing inefficiency in the market. This causes market failure. Seeing, this the govenment imposes taxes on such firms. There will be regulations and legislations introduced.

3. Imposition of taxes addresses such situations effectively and efficiently. This brings back the efficiency in the market as well as society, due to which demand gets equivalent to the supply. Tax will be imposed on polluters. Permits to pollute at certain level without disturbing air atmosphere will be sold.

4. Both the consumers as well as the producers get affected by the imposition of tax as they both give rise to negative externalities on their part. They will be giving taxes to the government.

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