Answer to Question #156943 in Economics for hello 1b

Question

Explain the problem of negative externalities in the market for energy (from carbon based fuels) as economists describe them.

Answer 1

Externalities occur when producing or consuming a good cause an impact on third parties not directly related to the transaction. Externalities can either be positive or negative. They can also occur from production or consumption. Positive externality occurs when consuming or producing a good causes a benefit to a third party. Negative externality occurs when consuming or producing a good causes a cost to a third party. The energy production by power plants that use carbon based fuels such as coal, crude oil or natural gas causes significant pollution. Pollution is a negative externality.

Let's consider the market for energy:

In the diagram abowe we can see the demand and supply for production the energy. The demand curve, $D$, shows the quantity of energy demended at each price. The supply curve, $S_1$, shows the quantity of energy supplied by power plants if they don't pay social costs of the pollution. But, in fact, the power plants payed additional costs of pollution when it produces energy, therefore, the supply curve shifts up by the amount of these costs. The supply curve, $S_2$, shows the quantity of energy supplied by power plants if they payed additional costs of pollution when it produces energy. As a result, the power plants pay social costs of the pollution, they create less pollution and produce less quantity of energy with higher price per unit of energy.