Question

Suppose that the production of a good generates a negative impact upon third parties. If the market does NOT take these negative consequences into account, then what is the expected market price and quantity?

Answer 1

Answer:

The price will decrease and the quantity of the product sold will increase.

Explanation:

The price quoted would be lower because the social costs are not part of the cost of the product. This would increase the demand of the product because financially it is more beneficial and the price demand relation says that when the price of the good decreases the demand of the product increases and vice versa. So this means that the company will earn more but the society will have to bear the cost of the negative impacts.

Answer 2

Answer:

The quantity offered of this product will decrease and consequently the price will also decrease.

Explanation:

When the production of a good has a negative impact on third parties, we have an example of economic externality.

In short, an economic externality is the term used to describe a situation where an industry generates negative, or positive, effects through the production of its goods or services. These effects are imposed on the population, customers and even third parties. Economic externality is considered an error in the production project, even if the effect is beneficial, because it generates costs that have not been analyzed and can change the supply and demand relationship.

When the effect of the externality is negative, the costs are high, because they include a social cost and a cost in production. All these costs must be borne by the industry. This will reduce the supply, since the production of the product will be very expensive. When the supply is reduced, the price of the product changes and is also reduced.