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The concept of negative externalities is crucial in understanding market dynamics and the impact of unintended costs on society. In this assignment, we will analyze the market for fertilizer in a local setting, where its production leads to pollution. Specifically, the external cost of pollution is estimated at $40 for each ton of fertilizer produced. The following sections will address the questions posed in the assignment.

1. Market Output Level and Price

To find the market output level and price, we must analyze the supply and demand curves for fertilizer. Let’s assume the demand curve for fertilizer is linear, and the supply curve reflects the production costs without accounting for externalities. The equilibrium is reached where supply equals demand. For example, if the equilibrium price (P) is $100 per ton and the equilibrium quantity (Q) is 200 tons, the market operates under the conditions where these two factors intersect. Consequently, the market output level is 200 tons, and the price is $100 per ton.

2. Social Cost Curve

The social cost curve includes the external cost associated with pollution. In this scenario, since the external cost of pollution is $40 per ton of fertilizer, we shift the supply curve upward by this amount to reflect the true cost of producing fertilizer. It results in a new equilibrium point being established at a higher price and lower quantity. If the original supply curve intersected with the demand curve at $100, the new social cost curve would intersect the demand curve at $140 per ton (reflecting the added externality) when the quantity produced adjusts to a new lower socially optimal level.

3. Socially Optimal Output Level and Price

The socially optimal output level can now be determined by identifying the point where the new social cost curve intersects with the demand curve. Suppose this intersection occurs at a price of $140 per ton and a quantity of 150 tons. This indicates that the socially optimal output level is 150 tons of fertilizer at a price of $140.

4. Comparison of Output Levels and Prices

Comparing the socially optimal output level and price to the market output level and price unveils significant insights. The market output level (200 tons at $100) is higher than the socially optimal level (150 tons at $140). This discrepancy highlights the inefficiency created by negative externalities. Specifically, the market fails to account for the external cost of pollution, leading to overproduction of fertilizer, which harms environmental and public health. By internalizing the external cost through a tax or regulatory measure, the market can adjust to a more efficient level of production.

5. Government Tax to Internalize External Cost

To internalize the external cost associated with fertilizer production, the government could levy a per-ton tax equivalent to the cost of the pollution. The calculated external cost of $40 must be imposed as a tax on each ton of fertilizer produced. This measure encourages producers to reduce output to the socially optimal level, aligning their private costs with the social costs.

Conclusion

In conclusion, understanding the dynamics of negative externalities and their effects on market equilibrium is essential for effective economic policy. Through this analysis of the fertilizer market, we see clear implications of unaccounted external costs, leading to market inefficiencies. By implementing a tax on production, the government can help achieve a more efficient allocation of resources that accounts for social welfare.

References

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