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Details:1. Identify and discuss three (3) externalities, which can either be positive or negative. 2. Conclude why an externality might exist in the situation that you described, and determine the solutions to mitigate these particular externalities. 3. Analyze the different stakeholders (i.e., government, three (3) affected parties) that are involved in the externality, and identify what their roles are with regard to the externality.
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Externalities exist when individuals engage in activities that influence the well being of the bystanders and neither receives compensation nor pays for that effect. If the effects imposed by the operations of a firm on the bystanders are adverse, this would be termed as Negative externality. If the effects on the bystanders are beneficial, this would be termed as a Positive Externality. In the advent of externalities, societal interests in a market outcome may extend beyond the well being of the sellers and buyers who take part in the market to include that of third parties. In the event of externalities, the market equilibrium fails to attain equilibrium since the affected buyers and sellers may neglect the external effects of their actions when deciding how much supply or demand. In this case, the equilibrium may fail to maximize the total benefit to the society (Mankiw, 2009, Pg. 204).
In a firm, externalities present themselves in various situations. The same way, policy responses may be derived in an effort to prevent market failure. For example, if a steel factory produces a lot of industrial emissions and wastes that may pollute the air and rivers, this may impose additional social costs. To the society, this situation poses as a negative externality. In this case, the government may respond to this situation by setting emission standards for industrial operations. It may also respond through imposing taxes on gasoline thus reducing the use of that fuel in the industries. The tools of welfare economics may be used to assess why externalities cause inefficient resource allocation.
Without government intervention, the price would adjust to balance the supply and demand for steel. The quantity produced and consumed in the market represented by Q in figure 1 would be efficient because it maximizes the sum of consumer and producer surplus. Now suppose that factories produce the pollutants. For each portion of steel produced a certain portion of smoke escapes into the atmosphere. This smoke poses a health risk to people; therefore, it is a negative externality. Now, let’s assess how this externality affects the efficiency of the markets outcome