A system of tradable emissions permits ("cap and trade") ensures that: those who can reduce pollution at least cost will do so pollution will be at the level where marginal social benefit equals zero pollution will be at the level where marginal social cost equals zero there will be no pollution

1. Externalities - Definition and examples 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 negative me dashed drop lines on the graph reflect the market equilibrium price and quantity for this good. positive 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. PRICE (Dollars per unit) QUANTITY (Units) Supply Demand Demand Supply

Identify a negative externality

This graph depicts an externality in a specific market: PMC represents the private marginal cost curve while SMC represents the social marginal cost curve: Price PMC ΠΟ F D A H /SMC Demand Quantity