Grade 10

Advanced

7 min

Lesson 8 of 12

Negative Externalities and Pollution

Not Started

Explore what happens when a transaction imposes costs on a third party, such as environmental damage.

If you buy a cheap burger, you pay for the meat and the bun—but who pays for the methane emissions and the healthcare costs of the pollution created by the farm?

Learning Objectives

1.Distinguish between Marginal Private Cost ( $MPC$ ) and Marginal Social Cost ( $MSC$ )
2.Identify the area of Deadweight Loss (DWL) on a market failure graph
3.Explain how Pigouvian taxes internalize external costs to reach social efficiency

The Gap Between Private and Public

In a standard market, we assume the price reflects all costs. However, negative externalities occur when a transaction imposes a cost on a third party who wasn't involved. A factory owner only considers the Marginal Private Cost (MPC)—the money spent on labor and materials. They often ignore the Marginal External Cost (MEC), such as air pollution or toxic waste. The true cost to society is the Marginal Social Cost (MSC), calculated as:

MSC = MPC + MEC

Because producers ignore the

MEC

, they produce more than is socially desirable, leading to a market failure.

Imagine a local bakery that uses a loud, smoky diesel generator to save money on electricity. 1. MPC: The bakery pays $10$ per hour for fuel. 2. MEC: The noise and smoke cause $5$ per hour in 'disutility' (stress and health issues) for the neighbors. 3. MSC: The total cost to the world is $10 + 5 = 15$ per hour. 4. Result: The bakery runs the generator too often because they only 'feel' the $10$ cost, not the $15$ cost.

Quick Check

If a chemical plant has an $MPC$ of $50$ per barrel and causes $20$ in environmental damage per barrel, what is the $MSC$ ?

Use the formula

MSC = MPC + MEC

Answer

The $MSC$ is $70$ .

Visualizing Market Failure

On an economics graph, the $MPC$ is your traditional supply curve. Because $MSC$ includes the external cost, the $MSC$ curve sits above the $MPC$ curve. The market equilibrium ( $Q_{market}$ ) occurs where $MPC$ intersects Demand ( $D$ ). However, the socially optimal quantity ( $Q_{opt}$ ) occurs where $MSC = D$ . Since $Q_{market} > Q_{opt}$ , the market overproduces the good. This overproduction creates a triangle of Deadweight Loss (DWL), pointing toward the socially optimal point, representing the net loss in welfare to society.

Consider a commuter deciding whether to drive to work. 1. The driver considers their own gas and time ( $MPC$ ). 2. They ignore the fact that their car adds to traffic, slowing down thousands of other drivers ( $MEC$ ). 3. On a graph, the $Q_{market}$ (number of cars) is much higher than $Q_{opt}$ (the efficient number of cars). 4. The resulting traffic jam is the physical manifestation of Deadweight Loss.

Quick Check

In a graph of a negative externality, does the market produce too much or too little of the good?

Answer

The market overproduces the good (too much).

Internalizing the Externality

To fix this, the government can force the producer to 'feel' the external cost. This is called internalizing the externality. The most efficient method is a Pigouvian Tax, a tax set exactly equal to the $MEC$ . By adding this tax to the production cost, the $MPC$ curve shifts upward until it aligns with the $MSC$ curve. This moves the equilibrium to $Q_{opt}$ , eliminating the Deadweight Loss. Other solutions include tradable pollution permits (Cap-and-Trade), which use market incentives to reduce emissions to the optimal level.

A factory has a demand for its product at $P = 100 - Q$ . Its private cost is $MPC = 10 + Q$ . The pollution damage is $MEC = 2Q$ . 1. Find Market Equilibrium: Set $MPC = P \rightarrow 10 + Q = 100 - Q \rightarrow 2Q = 90 \rightarrow Q_{market} = 45$ . 2. Find Social Optimum: $MSC = MPC + MEC = (10 + Q) + 2Q = 10 + 3Q$ . Set $MSC = P \rightarrow 10 + 3Q = 100 - Q \rightarrow 4Q = 90 \rightarrow Q_{opt} = 22.5$ . 3. The Tax: To reach $Q_{opt}$ , the government should set a tax equal to $MEC$ at the optimal quantity: $2 \times 22.5 = 45$ per unit.

Key Takeaways

1Negative externalities occur when the Marginal Social Cost ( $MSC$ ) is greater than the Marginal Private Cost ( $MPC$ ).
2Markets overproduce goods with negative externalities, leading to a misallocation of resources.
3Deadweight Loss is the area representing the social cost of producing units where $MSC >$ Marginal Benefit.
4A Pigouvian tax equal to the Marginal External Cost ( $MEC$ ) corrects the market by internalizing the cost.

Quick Check

Multiple Choice

Which of the following best defines a negative externality?

Multiple Choice

On a graph, where is the socially optimal quantity ( $Q_{opt}$ ) located?

True/False

A Pigouvian tax is intended to shut down an industry completely.

What's Next?

Review Tomorrow

In 24 hours, try to sketch a negative externality graph from memory, labeling $MPC$ , $MSC$ , $Q_{market}$ , $Q_{opt}$ , and the Deadweight Loss triangle.

Practice Activity

Research a real-world 'Carbon Tax' or 'Sin Tax' (like on cigarettes) and explain how it attempts to internalize an external cost.

Browse

Browse

Negative Externalities and Pollution

Learning Objectives

The Gap Between Private and Public

Visualizing Market Failure

Internalizing the Externality

Key Takeaways

Quick Check

What's Next?

Negative Externalities and Pollution

Learning Objectives

The Gap Between Private and Public

Visualizing Market Failure

Internalizing the Externality

Key Takeaways

Quick Check

What's Next?