Question

Many people who do not smoke cigars are bothered by the odor of cigar smoke. If private contracting is impossible and in the absence of any government involvement in the market for cigars, will too many or too few cigars be produced and consumed? From society’s point of view, will the market price of cigars be too high or too low?

Short answer

The production of cigars will increase and from society's point of view, the market price for cigars will be lower due to a decrease in the social cost of externality.

Step-by-step solution

Step 1. Define Externality.

An externality is a consequence of an economic activity that affects the third party. For example, pollution is an externality.

Step 2. Production and consumption of cigars.

Without government intervention prohibiting smoking will be difficult. There will be a negative externality as the smokers will smoke in public areas as well as open areas. The consumption of cigars will increase as the smokers will not look into the negative externality of smoking.

Step 3. Society's point of view.

The social cost of externality is ignored as the social cost curve shifts leftward than the market supply curve and the market price decreases due to a subsequent increase in the demand for cigars.