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Essay Questions for Microeconomics 101

  1. What is meant by an efficient market structure and compare and contrast perfectly competitive model with monopoly in the market place.

Or

  1. What is economic efficiency? How do negative externality such as air pollution affect the economic efficiency of Market equilibrium and suggest some policies that may help in overcoming this externality?

Definition of Economic Efficiency

Economic efficiency can be stated as that state in the economy in those cases where each and every resource will be optimally allocated for serving the individual in the best way. In case of an efficient economy, when a change is made in the entity it will be changing the other as well. Goods are generally produced at their lowest possible cost with variable inputs of production. Therefore, economic efficiency can be defined as a state where all the resource is generally allocated optimally such that each person is served the best possible way. In this case waste and inefficiency are generally minimized.  Some of the factors which affect the economic efficiency are that production of the commodities should be at the lowest cost. Another factor is that any one individual cannot gain by means of allocating the products without making the other person worse off. Economic efficiency also indicates that there need to be a presence of balance between the befit and loss. The key to attain the economic efficiency is specialisation by the division of labour (Griffin, & Bromley, 2018).  It is important to attain economic efficiency as resource is limited, they will provide maximum utility when they are put to best use. Therefore, the objective of every economy is to achieve efficiency such that maximum amount of benefit is achieved to everyone. Wealth creation can also be maximised by optimum efficiency of the resources. Therefore it can be said that a nation can become richer by better efficiency of utilisation of resources. Full production takes place when there is a presence of two kinds of efficiencies, one is the productive efficiency and the other is allocative efficiency. Allocative efficiency takes place when resources are used for producing the combination of the services and goods which is most wanted by the society (Jacobs & De Mooij, 2015). On the other hand productive efficiency means the cheap production techniques are used to produce the wanted services and goods

Air pollution can be defined as the mixture of solid particles and gases in the air which is harmful for the al living creatures. Air pollution can be termed as negative externality which affects the economic efficiency of the market equilibrium. A negative externality takes place when any firm makes a decision of not paying the full cost of the decision. When the good is negative externality the cost of the society will be greater than the cost which the consumer is paying for it. As consumers make most of the decisions then the marginal cost will be equal to the marginal benefit and the cost of negative externality will not be taking in to account. It will generally lead to negative externality in the market when roper actions are not taken (Jacobs & De Mooij, 2015). When the negative externalities takes place in the market which is not regulated and the producers will not be taking responsibilities for the external cost and will be then passed on to the other societies. Therefore, it can be said that producers will be having low marginal costs than they would have and then the supply curve will be getting shifted down which the society usually faces.  When there will be increase in the supply cure, then at that time more of the commodity will be brought  then at that time the amount in the equilibrium, it will mean that too much of the product is been produced and sold. There will be a case of loss in the welfare when the marginal benefit will not be equal to the marginal cost.  The graph above shows the effect of the negative externality related to the air pollution. Producers usually produce at the point A where the cost of production is given at point P and the amount of quantity produced is at the point Q. The point at production A is usually decided by the free market allocation and where both the supply and demand of the goods intersect at the point (Tietenberg, & Lewis, 2016). The curve MSC is marginal social cost and MPC is known as the marginal private cost. The marginal private cost which is MPC is the line which is the cost that the producers are paying in order to produce certain goods. On the other hand the marginal social cost will be that line which will be indicating the cost which will be paid by the society that needs to be produced.

Negative Externalities and Its Effects on Economic Efficiency

Therefore air pollution is the cost which the society is paying for the good s that causes air pollution. The air pollution also leads to indirect cost of production which includes crop damage and climate change. These costs take place in the point C.  Negative externalities take place when the marginal social cost of production is higher than the marginal private cost of product. In case of free market output is produced at the point where marginal cost is equal to the marginal benefit. In the first part it was assumed that people will be ignoring the external cost.  As a result of the externality the social cost of driving is much higher than the private cost which results to overconsumption in the market. The socially efficient level of output takes place at the point when the social marginal cost will be equal to the social marginal benefit.

Externalities are generally pervasive and an important phenomena in the modern world. The term externalities can be defined as the economic effects which take place from the production of goods to the other parties which can arise between both producers and consumers (Sun & Nie, 2015).  . For any output which will be greater than Q1, the social cost will be given by the difference which is the difference between the social marginal cost and the marginal benefit. The X axis measures the quantity demanded and the Y axis measures the cost and benefit which the society faces. The part ABC will be the dead weight loss in the economy. The deadweight loss of the economy is the loss of economic efficiency which takes place when the equilibrium for a good is not achievable. The deadweight loss is a kind of cost to the society which is created by the market inefficiency.

There are many policies which help in overcoming the negative externality. One of the way for reducing the negative externality is by imposing the pigouvian tax. The pigouvian tax is a kind of tax on the market activity which will generate negative externality. Pigouvian tax is intended in order to correct the inefficient market outcome. (Sun & Nie, 2015).  The pigovian tax was introduced for discouraging activities which impose a net cost of production on the societies and on the third parties. As negative externality prevent the market economy from reaching the equilibrium when the producers are not internalizing the cost of production. A pigovian tax is a kind of government cost on the activities which creates negative externalities.

Government Interventions for Overcoming Negative Externalities


The pigouvian tax will shift the marginal cost curve up by the amount of eternality here in the above diagram t represents the pigouvian tax. The above diagram shows that the negative externality is equal to point E and the equilibrium output is at QA. Now when the pigouvian tax is imposed for eliminating the negative externality from the society, the tax would decrease the output to the point Qs an increase the price at the point Ps which will be termed as the socially efficient equilibrium (Hanley, 2016).. The consumer surplus also gets reduced along with the producer surplus. The government will be gaining tax revenue equal to the area A+B+C+D. The agents will be gaining the point E+F+G. It can be the negative effects of the externality which results from air pollution can be eliminated using a pigovian tax. The marginal benefit curve represents the marginal cost of the factory as the output rises. The more the factory produces the more it will be polluting the environment.

Another way of reducing the negative externality which results as a result of pollution is through transaction cost which can be incurred through monitoring, enforcing and negotiating the market activities. The government can incur the financial cost which would help in reducing the environmental degradation in the economy. When the emission of gas can be reduced t will help in reducing the global warming in the economy. Less emission of gas would help in preserving the environment and will also help in reducing the environmental degradation.  The government can respond o externalities in two different ways. The government can also use command and control policies for regulating

Coase theorem can as help in reducing the negative externality. The coaase theorem states that the private economic factors can sole he problem of externalities among themselves. The reason behind this is that government interventions may not always help in help in addressing the solution. According to the Coase theorem there will be two parties which will be bargaining with each other in order to reach an agreement which efficiently addresses externality. In this case the transaction cost must be low enough in order for parties to arrive at a more efficient outcome. With there is a presence of externality, the private parties will come at the efficient outcome when there will be an intervention of the government.


As air pollution affects the environment negatively the government intervention is needed in order to reduce the market failure which results from negative externalities. One way of overcoming the negative externality is by imposing the pollution tax. One of the methods to reduce the negative externality is to tax those who create negative externalities which is also known as making the polluter pay (Ringquist, 2016). When a tax will be introduced, it will increase the private cost of consumption and ought to reduce the demand along with the output which will be creating the externality. An environmental tax will be a kind of tax on the goods which help in reducing negative externality. When tax will be imposed

  • It will increase the private cost for producing goods and therefore both the producer and the consumer will have to pay for the negative externality which will be promoting the allocative efficiency.
  • In this way the government will be providing incentives to the producers for taking the externalities.
  • When the environmental tax is well defined it will encourage innovation and development of new technology.

Pigouvian tax


Allocating property rights to the environment will also reduce negative externality. The reason behind overproduction of environmental beds and under production of environmental goods is the absence of private property rights in the environment (Sun& Nie, 2015). This will give rise to market failure which will be leading to negative externality. The environmental problem can be resolved when the government can ensure property rights in the environment.

Market based instruments can also be used for tackling pollution. The market based instruments can help in creating incentives which will encourage people which will help them to treat the environment in a way which will be the best interest to the society.  There are reasons of two market based solut0ns for controlling the pollution which are fiscal measures and trading in emissions quota (Hanley, 2016). Environmental economics: in theory and practice. Macmillan International Higher Education.. The market based instruments are also known as the price based instruments which can alter the prices of goods and services.

The emissions permit trading is a market based scheme which uses economic mechanism for minimization of the total cost in order to meet a particular pollution target.

Reference list

Canterbery, E. R., & Marvasti, A. (1992). The Coase theorem as a negative externality. Journal of Economic Issues, 26(4), 1179-1189.

Demir, E., Huang, Y., Scholts, S., & Van Woensel, T. (2015). A selected review on the negative externalities of the freight transportation: Modeling and pricing. Transportation research part E: Logistics and transportation review, 77, 95-114.

Gahvari, F. (2014). Second-best pigouvian taxation: a clarification. Environmental and Resource Economics, 59(4), 525-535.

Griffin, R. C., & Bromley, D. W. (2018). Agricultural Runoff as a Nonpoint Externality; A Theoretical Development. In The Theory and Practice of Command and Control in Environmental Policy (pp. 43-48). Routledge.

Hanley, N. (2016). Environmental economics: in theory and practice. Macmillan International Higher Education.

Iossa, E., & Martimort, D. (2015). The simple microeconomics of public?private partnerships. Journal of Public Economic Theory, 17(1), 4-48.

Jacobs, B., & De Mooij, R. A. (2015). Pigou meets Mirrlees: On the irrelevance of tax distortions for the second-best Pigouvian tax. Journal of Environmental Economics and Management, 71, 90-108.

Laszlo, C., & Zhexembayeva, N. (2017). Embedded sustainability. In Embedded Sustainability (pp. 116-140). Routledge.

Low, P. (2016). International trade and the environment. UNISIA, (30), 95-99.

MacKenzie, I. A., & Ohndorf, M. (2016). Coasean bargaining in the presence of Pigouvian taxation. Journal of Environmental Economics and Management, 75, 1-11.

Panayotou, T. (2016). Economic growth and the environment. The environment in anthropology, 140-148.

Ringquist, E. J. (2016). Environmental Protection at the State Level: Politics and Progress in Controlling Pollution: Politics and Progress in Controlling Pollution. Routledge.

Rosenzweig, A. (2017). How Pigouvian Taxes Work on Sellers, and Why We Should Care. Jotwell: J. Things We Like, 74.

Sun, P., & Nie, P. Y. (2015). A comparative study of feed-in tariff and renewable portfolio standard policy in renewable energy industry. Renewable Energy, 74, 255-262.

Tietenberg, T. H., & Lewis, L. (2016). Environmental and natural resource economics. Routledge.

Weimer, D. L., & Vining, A. R. (2017). Policy analysis: Concepts and practice. Routledge.

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