Market failure associated with negative externality

In this paper, emphasis shall be put on the examination of negative externalities taking Brick industry in Kathmandu valley, Nepal as the industry case study.  A negative externality can be defined as an external diseconomy or cost. It arises when the unrelated third party is impacted by a certain economic undertaking especially during the process of consumption and production (Ruiz, 2012).  

Market failure associated with negative externality

There are a number of negative externalities that are evident in today’s economy and they include air pollution, noise pollution, water pollution, spam, systematic risk, passive smoking, antibiotic resistance, traffic congestion among others (Gallice, 2018). Therefore the above consequences of economic undertakings have a strong negative influence which results into market failure. This is due to the fact that there is no true reflection of the exact benefits and costs of the product by the equilibrium. It should be noted that an ideal equilibrium is supposes to effectively tantamount into production level that is optimal. In other words an optimal level that truly reflects  the  proper balance between the costs of producers and the benefits of the buyers. The movement there arises  a significant externality in most cases , the level of equilibrium is effectively flawed. This creates incentives  which makes certain actors undertake choices or decisions that makes a particular group more worse making marketing failure un avoidable ( Rhona, 2010).

The supply and demand diagram can also be used to illustrate the economics of externalities. From the graph above, assuming the brick industry is operating in a market that is competitive, before the imposition of pollution control regulations, the overall social cost is greater than the private marginal cost ( Jek and Tan, 2010). For instance water and air pollution cost. The above can effectively be represented by the two curves vertical distance on the diagram. There is an assumption of non existence of external benefits . Thus the individual and social benefits are equal. For instance where the private cost of the consumer is put into consideration, the resultant quantity will be  Qp and resultant price will be Pp. This will be contrary to the efficient quantity  Qs and efficient price  Ps. Hence it can be argued that the latter reflects that marginal social cost and marginal social benefit are equal. This means that the overall levels of production have to be increased until whenever the marginal social costs are exceeded by  the marginal benefits. The above means that there is inefficiency in the free market  given that at  Qp (quantity), the social costs are more than the social benefit. Meaning that if goods Qp and Qs were not produced, the society would be better off (Mankiw 2014).

Home industry that creates externalities

Home industry that creates externalities

The industry chosen which creates a negative externality is Brick industry in Kathmandu valley, Nepal. The increase in demand for bricks throughout the area of Nepal has not spared the environment. There exists a number of externalities that have been created by the establishment of the brick industry in Kathmandu valley, Nepal. These ranges from air pollution, noise pollution, land pollution among others. Important to note is that  the brick industry in the area of Nepal is still underdeveloped with wide use of low technology and other forms of intensive labor (Griffiths & Wall, 2011). Therefore the utilization of such technologies make negative externalities like pollution unavoidable through the area. The brick industry is listed among the popular contributors to environmental degradation and other health hazards in the area of neple (Steffen, 2012). There is a reduction in the air quantity which has resulted into a number of air diseases such as bronchitis, asthma, silicosis among other pulmonary diseases. 

Moreover, pollution is a negative externality with a number of social costs. The social costs are grouped into the external pollution costs passed onto the community and the production incurred by the organization. Therefore the presence of the brick industry alone in the area of Nepal creates a number of negative externalities which generally affects the overall social welfare of the community (William, 2016).

From the diagram above brick production results harmful consequences to the third parties such as air pollution. It should be noted that in agree market economy, there is a tendency of producers not to put into consideration the overall external costs affected by  other individuals. Hence forth the overall total output levels  shall be  the level of Q1. in  other words where the overall level of  demand is equal to supply (Qd=QS)

Therefore in the  above diagram  the dead weight  welfare loss is located in the red triangle. This clearly shows the overconsumption area (SMC<PMC). market failure associated with negative externality (Campbell, 2009).

Therefore the negative externalities associated with the presence of the brick industry in the area of  neples creates a number of implications that automatically leads into a market failure. The main reasoning behind this is the overall costs incurred  by other people are not put into consideration by individuals. Important to note  is that the presence of negative externalities makes it difficult for the producer to effectively incur the total costs emanating from production that is excess. It should be noted that, when there are positive externalities , all the benefits of the good are not enjoyed by the buyer which results into relatively lower levels of production. Therefore the overall costs of  pollution arising from the brick industry are borne by the industry itself, it is the society that suffers (Gallice, 2018).

How does the government address the negative externality in your case study?

How does the government address the negative externality in your case study?

The negative externality occurs when there is the reduction in the wellbeing of the third parties as a result of the firm’s production and there is no compensation offered to them by the firm. The brick industry in Nepal grow is being ranked to be growing the fastest speed in the world(Haack&Khatiwada, 2007). However, the constant growth in the industry in the country is associated with a number of rising externalities. These externalities involve both negative and positive externalities, however, in this paper the major emphasis will be put on the negative externalities. The negative externalities arising from the brick industry pose greater threats to the third parties and in most cases, the industry minds less to compensate them(Liz, 2012). These externalities cause market failures.

Among the major externalities arising due to industrial activities include pollution which takes various ways such as noise, air, water and land pollution. These kinds of externalities are harmful to the wellbeing of the third parties they tend to contribute negatively to their standards of living and sometimes increases the costs of living (Haack&Khatiwada, 2007). Therefore, this calls for the interventions of the government to reduce on the impact of the negative externalities arising from the Brick Industry.

The Nepal government is much aware of the crucial environmental threats that arise from the brick kilns. Despite the increasing demand and supply of bricks as the construction materials, the governments through its agencies and in partnerships with other private organizations have established endless efforts to address the increase hazards to the environment arising from the brick industry activities (Liz, 2012). It has joined hands with the watchdogs to establish appropriate policies that can help in regulating the activities of the brick industry such that negative externalities can be minimized in the country. For instance, the government has designed several policies to ensure that the growth of the kilns is minimized. The policies are implemented through closing up and cleaning up some of the kilns. This is done to reduce on the threats posed to the environment such as air, water, noise and land pollution which result in negative externalities to the third parties. The government has established the several motions that will help in putting in place the standard environmental performance through the enforcement and the legislation is still weak.  

However, the government of Nepal addresses the negative externalities arising from the Brick Industry in Kathmandu Valleythrough the introduction of the pollution taxes. This is the common approach that is used by the government when reducing on the threats that are posed to the environment by the activities of the industry (Pettinger, 2017).

The pollution taxes, in this case, are imposed on the quantities and production processes in the industry. The major aim of the introduction of these taxes is to increase the production or consumption of private costs. Thus, the target of the government policy is to reduce increase on the costs of production that helps to reduce on the production units. In return, this leads to an increase in the prices thus reducing on the demand for the bricks that are cited to be causing negative externalities (Liz, 2012). In this case, a larger proportion of the revenues obtained from the pollution taxes imposed on the brick industry is used in the projects that are aiming at protecting the environment from all kinds of destruction (Liz, 2012). For instance, the revenues collected is used in refining the water, planting more trees and hiring more manpower to monitor and protect the forests from the destruction of the firms engaged in the bricklaying activities.

The taxes levied on the block industry has forced out many firms out of production due to high costs of production. The exiting of several firms from the industry has helped to reduce the industry activities that has resulted in the reduction of the externalities.

On the other hand, the taxes levied on the brick industry and its activities have led to an increase in the prices of the industrial products such as bricks. The increase in the prices has resulted in the reduction in the demand for these products (Thygerson et.al, 2016). Thus, this has led to the reduced activities in the industry that pose a great threat to the environment and minimizes the externalities on the third parties. Since the industry cannotcompensate the third parties for its negative externalities caused, the government uses the tax revenue to compensate them. This is carried out throughproviding health care service, air refinement, and purifications among other ways of reducing on the impact of negative externalities. This concept can be better explained using the Coase Theorem.

An Illustration of the impact of the pollution tax on the Brick Industry in Kathmandu Valley, Nepal

In this case, the Social Marginal cost of producing the bricks is more than the private marginal costs. The difference is being determined by the difference between the pollution’s external cost. Due to the imposition of the tax, there is the shift in the supply curve to S2 which will force the consumers to incur all the social costs. Thus, this leads to the reduction in the quantities consumed from Q1 to Q2 that will act as the socially efficient outcome.

This can help to address the market failure by enabling the government to raise significant revenues that can be used in financing schemes that reducing on the pollution such as offering subsidies to the alternative building materials. More so, the tax helps in providing the market incentive. This forces firms that are engaged in the industry to provide more efficient ways which help in reducing the pollution cases. Thus, are effective ways that arise from the pollution tax that is levied by the government of Nepal to reduce on the negative externalities arising from industrial activities.

The Brick industry in Kathmandu Valley, Nepal falls under one of the four market structures. The four market structures are differentiated by these attributes; product type, losses and profits within the long and short run, the number of buyers and sellers within the market, freedom of entry and exit of firms into the industry. These market structures are; Perfect competition, Monopolistic competition, Pure Monopoly, and Oligopoly.

Perfect competition is a rare market structure and seems not to exist but is used in the analysis of industries that possesses characteristics of pure competition (Elmer G. Weins, 2014). Perfect competition is characterized by standardized or homogenous products which means each product owned by each seller is identical compared to other’s products, it’s also characterized by free exit and entry of firms into the industry: means no barriers preventing firms from joining or exiting the industry (Akimaya & Dahl, 2018). It is also characterized with many sellers, this means that the decision made by the single seller cannot affect the market price. The other characteristic is the different firms within the industry are price takers, this means they accept the price in the market and have no influence on it. Considering the nature of demand curve in this type of market structure, the demand of goods for individuals firms is perfectly elastic because firm’s price is constant no matter what quantity they produce since they are price takers (Saez, 2018).

 In the short run period a firm owns fixed resources, it only makes profits or reduces loss through adjusting output. Firms should only carryout production when total revenue is greater than total cost so as to make profits(Dimopoulos  &Sacchetto, 2017). This sometimes becomes impossible therefore firms carrying out less production in the short run. If -FC>EP, the firm has to close to avoid loss. In the long run, if there is earning profits, firms enter and increase market supply causing price falls. Till when no economic profits are made that’s when supply becomes steady (Akimaya & Dahl, 2018). Therefore in the long run, firms achieve equilibrium. Production in the long run will take place at the point of firm’s minimum mean total costs(Cole e t al, 2017).

 Pure monopoly market structure is characterized with the existence of a single firm within the industry as the only producer of a commodity having no close substitutes (George Brown College,2014). Some of the examples of such industries are professional sports leagues and public utilities. Pure monopoly is characterized by single seller within the industry, unique product, exit and entry is blocked, and also firms are price markers. In this type of market structure, the firm will make both profits in short and long run. Another common characteristic under this is price discrimination where the same commodity takes on different prices at different locations.Inorder to carryout price discrimination; the firm has to make sure buyers donot resell the products, it should be in position of segregating the market.The demand curve of firm under monopoly is downward sloping. This is because firms will be in position of reducing price to increase their sells.

The other market structure is monopolistic competition, this is market structure has relatively big number of sellers dealing in similar butproductswhich are not identical. Example of firms in this market structure are the fast food restaurants. This structure is characterized with many firms in market each sharing a market percentage, these firms deal in differentiated goods, and there is also easy exit and entry.The firm’s demand curve is very elastic rather not perfectly elastic(Coglianese e tal, 2017). In the short run firms barely make high profits but in the long run firms’ price is greater than the marginal cost thus making reasonable profits.There is also a situation of break even for the existing firms in the long run.In this market structure,the various styles, product quality, and brands are used in offering consumers choices (Jungherr e t al, 2018).

The other type of market structure is Oligopoly, this only exits where there are few firms within the industry dealing in production of differentiated or homogeneous products as well as dominating the market. Such firms include gasoline and automobile industries. The characteristics of this market structure are; production of differentiated or standardized goods, the entry is hard, there are few firms which are large. Because of tacit collusion or competition among these firms, the demand of products of these firms is inelastic at price cuts, and at price rise its elastic. Therefore there demand curve is Kinked(Jungherr  e t al, 2018)

Kathmandu Valley has over 500 brick Kilns which are used in production of bricks owned by different individuals and households. In the industry there is no restricted entrance of any individual household to participate into the brick industry except interventions by the government emphasizing the masses to acquire more environment friendly technologies for brick production so as to overcome pollution. The different firms are not price determinants and they are facing stiff competition among themselves. These products are differentiated basing on the quality of production (Hayn e tal,2018). Considering the different four market structures, this brick industry cannot be referred to as monopoly market structure because there is more than one firm dealing in the production of bricks; it cannot neither be referred to as Oligopoly market structure because firms offering production are not very large and they are very many(Hayn e tal,2018). This kind of market structure cannot be referred to as perfect monopoly though firms are not price determinants and there is free entry and exit within the industry because there is no perfect knowledge of commodities produced by the firms for sale by the buyers (Saez, 2018). Therefore, the perfect market structure for this type of industry is Monopolistic market structure (Hayn e tal,2018). Monopolistic market structure qualifies because there is easy exit and entry of firms, there are a lot of firms within the industry, and lastly the products produced are differentiated basing on their quality (Akimaya & Dahl, 2018).

There a number of ways that can be utilized to measure the overall levels of efficiency of the brick industry in nepals. These include the price elasticity, price levels , resource allocation among others. The presence of price costs is a barrier to perfect competition. Therefore decreases in the above costs lead into a fall in the product prices. The effects are usually more stronger where mare products are same (Hayn e tal,2018). Basing on several studies the level of efficiency of the brick industry is lower compared to other markets ( Jek and Tan, 2010).  The elasticity of demand measures the overall level of responsiveness of sensitivity of customers  to changes in price (Gallice, 2018).

The brick industry  has a high level of  price elasticity of demand. in other words increases in price affects the overall demand levels negatively (Liz, 2012). Customer are very sensitive to taxes  put on bricks. It should be noted that Perfect competition is characterized by standardized or homogenous products which means each product owned by each seller is identical to other’s products, it’s also characterized by free exit and entry: means no barriers preventing firms from joining or exiting the industry (Afonso &Kazemi, 2017).

 It’s also characterized with many sellers, this means that the decision made by the single seller cannot affect the market price, therefore for this case, it can be  asserted that Therefore the overall levels of efficiency of this industry are low with unstable prices and frequent changes in consumer tastes and preferences which cannot be effectively fulfilled by the industry(Hayn e tal,2018). The overall levels of competition are also high in the industry with many competitors, however the overall quality levels produced by the industry are still low (Liz, 2012). 

Conclusion

Conclusively, negative externalities pose a number of consequences which affects the efficiency and effectiveness of different markets. Therefore for the case of Kathmandu Valley brick industry, there is an urgent need to tough the existing regulation in order to get rid of the social costs as analyzed above. 

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