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

a) The firm creates an externality since they emit noxious fumes, which are detrimental to health.

b) Private bargaining is unlikely to resolve the problem.

c) The community could determine the efficient level of air quality where the families’ willingness to pay for houses equals the marginal cost of pollution.

Step-by-step solution

Firms create negative externality by emitting noxious fumes

The toxic fumes emitted by the firms in the production process impose a social marginal cost on the society in the form of severe health problems such as; difficulty in seeing, severe respiratory problems, breathing problems, skin problems, and others.

Bargaining power will not resolve the problem

Since the residents did not anticipate the firm’s location before settling in the eastern part, the housing prices could not reflect the given information, and the externality effect was not considered. Due to a large number of families, private bargaining seems difficult. The willingness to pay for a better air quality cannot be known. Further complications are added if the citizens have employment relations with the firm.

Willingness to pay must equate to the marginal cost of pollution reduction

The efficient level of air quality will be determined where the aggregate willingness to pay for the houses equals the firm’s cost of abatement. This will determine that both parties will have to bear the least marginal social cost, and the marginal social benefit of both the residents and the firms will increase.