Question

 An externality arises when a firm or person engages in an activity that affects the wellbeing of a third party, yet neither pays nor receives any compensation for that effect. If the impact on the third party is adverse, it is called a _______  externality.

 The following graph shows the demand and supply curves for a good with this type of externality. The dashed drop lines on the graph reflect the market equilibrium price and quantity for this good.

 Shift one or both of the curves to reflect the presence of the externality. If the social cost of producing the good is not equal to the private cost, then you should shift the supply curve to reflect the social costs of producing the good; similarly, if the social value of producing the good is not equal to the private value, then you should shift the demand curve to reflect the social value of consuming the good.

 With this type of externality, in the absence of government intervention, the market equilibrium quantity produced will be than the _______  socially optimal quantity.

•  Which of the following generate the type of externality previously described? Check all that apply.

•  Your roommate Amy has bought a cat to which you are allergic.

•  The city where you live has turned the publicly owned land next to your house into a park, causing trash dropped by park visitors to pile up in your backyard.

•  Kenji has planted several trees in his backyard that increase the beauty of the neighborhood, especially during the fall foliage season. 

•  A leading software company has decided to Increase its research budget for Inventing new open-source technologies.

Answer 1

If impact on third pary is adverse it is called negative externality

To show a negative externality we would have to shift the supply curve to the left since social cost is not equal to private cost.

Examples of negative externailiies:

1) roomate has bought cat to which you are allergic

2) The city developed a park , causing trash to pile up in your backyard

These two provide adverse effect to agents who are not participating in the exchange

The other two examples are of positive externality which give benefits to third party agents who are not part of the exchange.