Negative externalities

A negative externality is a cost imposed on a 'third party' as a result of the activities or buyers or sellers.

Most transactions in market economies create externalities - some of which are beneficial - yet not paid for by the beneficiaries - and some have a detrimental effect on others, although they are not compensated by those causing the negative effect.

An example of an external cost of consumption is the amount of waste plastic discarded after use. An external cost of production might include the chemical pollution resulting from the processes of production and of distribution.

Factories use energy which may be derived from fossil fuels. Other types of production directly result in pollutants, including chemical waste as a by-product of clothe production.

Graphically, external costs shift the marginal social cost curve to shift to the left. Socially-efficient production and consumption occur at the output where marginal social cost equals marginal social benefit, at Qs. Net welfare loss is area A, B, C.

Negative externalities
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  1. Carbon taxes could help reduce production to a more socially efficient and sustainable level, with demand contracting from A to B. As is often the case, the effectiveness of a tax depends on the consumer’s PED for the polluting product.
  2. Banning production which emits carbon and other waste.
  3. Using pollution permit schemes, which encourage firms to reduce their emissions.
  4. Subsidies to producers to switch to greener technology.
  5. Allocating ownership rights to open spaces, waterways and beaches so that polluters can be privately sued if they pollute.
  6. Public information programmes.
  7. Small nudges to change behaviour.

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