Question

Match each of the following characteristics or scenarios with either the term negative externality or the term positive externality.

a. Resources are overallocated.

b. Tammy installs a very nice front garden, raising the property values ofall the other houses on her block.

c. Market demand curves are too far to the left (too low).

d. Resources are under-allocated.

e. Water pollution from a factory forces neighbors to buy a water purifier

Short answer

1. Negative externality
2. Positive externality
3. Positive externality
4. Positive externality
5. Negative externality

Step-by-step solution

Step 1. Explanation for part (a)

Resources are overallocated when the production of a good exceeds its optimal level. This optimal level is the level that offers maximum welfare to the society. Its determination includes external costs/benefits of a production activity as well. A good is said to be overproduced when it has a negative externality.

The external costs are ignored while calculating the equilibrium price and quantity. The private costs reflect a lower cost of production, and hence, the supply of a good is higher than its optimal level. Thus, overallocation of resources means the presence of negative externality.

Step 2. Explanation for part (b)

When Tammy installs a garden that increases the property values of the houses in the vicinity, it shows the positive spillover effects of production activity or positive externality.

The nearby property owners receive these external benefits without paying for the installation of the garden. These people were the third party who got to enjoy the positive externality effect of installing a garden.

Step 3. Explanation for part (c)

If the market demand curve is too left, that means the demand curve only reflects the demand of consumers who get direct benefits of consuming a good or service and does not include consumers who are getting external benefits from the consumption of the good or service. This is the case of a positive externality, where a lower demand curve results in the underproduction of a good or service.

Step 4. Explanation for part (d)

Resources are underallocated when the production of a good is less than its optimal level. This happens when the demand curve does not include the consumers who are getting external benefits, and hence equilibrium price and quantity do not reflect the optimal level. Therefore, the supply of a good is lower than its optimal level. Thus, underallocation of resources means the presence of positive externality.

Step 5. Explanation for part (e)

The water pollution from a factory puts a cost on neighbors who were not considered when the allocation and distribution of resources were being decided. These people have to bear the cost of buying water purifiers due to the outcome of the production activity. These are external costs that show that water pollution results in negative externality.