Externalities – Traffic Flow Increase Caused By Water Park Construction

Negative externality of consumption

The $ 6 cost to every person of the community as a result of the construction of the water park is considered to be a negative consumption externality. The neighborhood in which the construction of the water park will be the beneficiary of the project and therefore the cost $6 per head is due to the aspect that they will beneficiaries of the project and thus the consumers of the water park and therefore must incur some cost.

 

In the negative externality of consumption, the MPB does not reflect social benefit, hence, MSB lies below the MPB. The vertical difference existing between MSB and MPB depicts the negative externality. The consumption optimal level is depicted when MSB=MSC, that is Q* (Mankiw & Taylor, 2007). Nevertheless, the negative externality is ignored resulting to an over consumption of the water park at Q1.

The per-unit amount of externality is the amount of negative or positive externality realized for every unit of the good produced by the city council.

Positive Consumption externality

In this case, when the businesses and the community around realize increased security during the night, this creates a benefit as a result of water park construction.  Moreover, the benefit of $3 for every water park attendee, the realized externality is a positive externality of consumption. Thus, this results to a positive externality due to the fact that the city council will never get refund for that money, and also neither the businesses nor surrounding neighborhood will have to pay for the additional benefit as a result of increased security due to heavy foot and street traffic at night. The per-unit amount for both the externalities is $2.

As depicted from Graph B above, the MPB lies below the MSB and the difference between these two lines consists of the positive externality.  MSB=MSC, that is at Q* is the socially optimal level, however because of under-allocation of resources the consumption/output is at Q1.

Government and private solutions for efficient outcome

Private-sector solutions

Individuals can demand from the city council to compensate for the added costs on the part of the community through reduction of some of the services they offer to the people in the water park.

Public remedies for externalities

Subsidies

When the government gives producers subsidies with positive externality this results to increased supply and thus shifts the supply curve downwards (Cornes & Sandler, 2009). Consequently, the MSC curve shifts to MSC + subsidy, depicting that high consumption/ output at socially optimal level, the price stabilizes at a lower level, for instance P1 to P*.

Through advertising

When the government makes an attempt to put a positive advertising, it can persuade consumers to raise their consumptions and hence leading to a shift of MPB to the right due to increased demand. The MPB curve shifts enough to coincide with MSB and Q* will finally be produced and consumed.

The pricing policy-the government would impose a corrective tax or a subsidy which is equal to the marginal damage (MD) per unit the externality has caused (Cornes & Sandler, 2009).

The Quantity regulation-government can force the firms to regulate their production and produce a socially efficient quantity.

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