Supply-Demand Analysis of Environmental Externalities
Basic supply-demand analysis can be used to explain both how externalities lead to environmental problems and how these problems can be cured. As an illustration, consider the damage that massive generation of garbage does to our environment. be comparably high . For the community depicted in the graph, the price of garbage removal will be P dollars per ton, and 10 million tons will be generated (point A).
But what if the community’s government decides to remove garbage “free”? Of course, the consumer still really pays through taxes, but not in a way that makes each person pay for the quantity of garbage that he or she produces. The result is that the supply curve is no longer SS. Rather it becomes the blue line TT, which lies along the horizontal axis, because any household can increase the garbage it throws away at no cost to itself. Now the intersection of the supply and demand curve is no longer point A. Rather it is point E, at which the price is zero, and the quantity of garbage generated is 25 million tons-a substantially greater amount.
Similar problems occur if the community offers the oxygen in its waterways and the purity of its atmosphere without charge. The amount that will be wasted and otherwise used up is likely to be enormously greater than it would be if users had to pay for the cost of their actions to society. That is a key reason for the severity of our environmental problems.
The magnitude of our pollution problem is attributable in large part to the fact that the market lets individuals, firms, and government agencies deplete such resources as oxygen in the water and pure air without financial charge.
It follows that one way of dealing with pollution problems is to charge those who emit pollution, and who despoil the environment in other ways, a price commensurate with the costs they impose on society.
