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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.

Quantity of Steel (m tonnes)

Price car makers are prepared to pay, based on expected private benefit (£)

Price steel makers are prepared to receive, based on their private production costs (£)

Estimated external costs to society of pollution  (£)

1 10000 1000 1000
2 9500 2000 1500
3 9000 3000 2000
4 8500 4000 2500
5 8000 5000 3000
6 7500 6000 3500
7 7000 7000 4000
8 6500 8000 4500
9 6000 9000 5000
  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.


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