Question

Externalitiesa.Assume excessively large SUVs include spillover costs that are not borne by the initial consumer but rather society as a whole. Explain two negative externalities associated with SUVs. Who pays the external costs? Identify the current price and output and the socially optimal price and output.
Use MSB and MSC to explain if SUVs are being overallocated or underallocated by the free market. Explain why the free market failed? Explain what the government must do to fix this negative externality?

Answer 1

Answer:

2 negative externalities of Large SUVs : Air (Gas) Polluters ; Lesser Disproportionate road usage & safety for other small vehicles.

Free Markets have over allocated, Government should levy pigouvian tax to correct negative externality impact

Explanation:

Negative Externalities are extra harm (social cost) to other parties, without compensating them for the same.

SUVs have negative externality , extra cost (harm) to society as :

• These bigger vehicles consume more fuel & gas, are more air polluting.
• These consume more road space, leave lesser road access & also less safety for small vehicles.

External (social) Cost borne by others are paid in monetary terms by nobody.

• Current market price would be where Private Benefit = Private Costs, ignoring Social Benefit/Cost.
• Socially optimal price & output is where Total Benefit (Private Benefit + Social Benefit) = Total Cost (Private Cost + Social Cost)

SUVs having unevaluated extra social costs - have been over allocated by free market. Free market fail as it doesn't incorporate the effect of extra social cost. Government should levy a tax called 'Pigouvian Tax' = Marginal Social Cost to internalise the extra social cost & reduce the over allocation of SUVs.