Question

A number of firms have located in the western portion of a town after single- family residences took up the eastern portion. Each firm produces the same product and in the process emits noxious fumes that adversely affect the residents of the community. a. Why is there an externality created by the firms? b. Do you think that private bargaining can resolve the problem? Explain. c. How might the community determine the efficient level of air quality?

Short answer

The firms are creating a negative externality by emitting harmful fumes that affect the residents who didn't choose to bear this cost. Private bargaining may help but faces issues like coordination and fair representation. The community can determine the efficient air quality level by comparing the cost and benefits of different pollution levels.

Step-by-step solution

Understand the Concept of Externality

An externality is a cost or benefit that affects a party who did not choose to incur that cost or benefit. In this case, the firms produce a negative externality by emitting noxious fumes as a result of their manufacturing processes which adversely affect the residents of the town.

Identify the Externality

The externality created by the firms is the emission of noxious fumes which affects the quality of life for the residents in the east portion of the town, without them having any choice in the matter nor any direct compensation.

Private Bargaining and Potential Issues

Private bargaining between the firms and the residents could potentially resolve the issue. However, this would entirely depend on the willingness and ensuring fair representation of all affected parties. Coordination between all residents could be challenging, and companies might not fully compensate for the damage done.

Efficient Level of Air Quality

The community might determine the efficient level of air quality by estimating the costs and benefits of different levels of pollution. Efforts should be made to reduce pollution to the point where the cost of further reductions would outweigh the benefits. This could be done through town meetings, surveys, or hiring an external environmental analyst.

Key concepts

Negative Externality

When a firm or individual engages in an activity that impacts others negatively without these parties being compensated, this situation results in what economists call a **negative externality**. In the given scenario, the noxious fumes emitted by the firms operating in the western part of the town exemplify such an externality. The residents living in the eastern portion face this problem firsthand, as the air quality deteriorates and affects their wellbeing without their consent or a compensatory mechanism in place.

Key aspects of negative externalities include:

• Involuntary Impact: Residents suffer from pollution they did not consent to.
• Lack of Direct Compensation: There is no immediate direct compensation from the firms to the residents.
• Overlooked Costs: The social costs, such as health impacts, are not reflected in the price of the products being manufactured.

Understanding negative externalities is crucial because they often lead to overproduction and consumption in the market, thus creating inefficiencies.

Private Bargaining

Private bargaining refers to a potential solution where affected parties negotiate directly to resolve issues caused by externalities. In this context, it would involve negotiations between the western town firms and the eastern town residents to address the pollution problem. Ideally, through private bargaining, firms might agree to reduce emissions or compensate residents in some way in exchange for continuing business operations.

However, several challenges can arise during private bargaining:

• High Transaction Costs: Organizing all affected residents to negotiate effectively might incur significant costs.
• Coordination Issues: All residents may not have the same ability or willingness to engage in negotiations, leading to uneven representation.
• Information Asymmetry: Firms and residents may have unequal access to information regarding the harm caused and the costs of reducing emissions.

Successful private bargaining requires transparent communication and fair representation, but these issues often make it difficult to achieve satisfactory outcomes without additional interventions.

Efficient Level of Air Quality

Determining the efficient level of air quality involves finding a balance where the benefits of cleaner air outweigh the costs of achieving it. This process requires a comprehensive assessment of both economic and social factors.

Here's how the community might approach it:

• Cost-Benefit Analysis: Calculate the total costs of reducing emissions versus the health and environmental benefits gained from cleaner air.
• Community Engagement: Conduct town meetings or surveys to gauge the residents' willingness to pay for improvements and their tolerance for existing pollution levels.
• Expert Consultation: Hire environmental analysts to provide data-driven insights into optimal emission levels and feasible reduction strategies.

By aligning community preferences with scientific recommendations, the town can work towards an air quality standard that reflects the true societal costs and benefits, ensuring a more sustainable and healthy environment for everyone involved.