How is inefficiency related to both the negative externalities as well as positive externalities? Explain with the help of appropriate diagrams

Inefficiency is closely linked to externalities, both negative and positive, and can be illustrated using the concept of market failure.

Get the full solved assignment PDF of MEC-006 of 2023-24 session now.

Let’s consider each case:

1. Negative Externalities:

• Market without Intervention (Inefficient): In the presence of negative externalities, a free market tends to overproduce the good or service causing harm to third parties. The market quantity (Qm) exceeds the socially optimal quantity (Qs), leading to overconsumption.
• Diagram:

1. Positive Externalities:

• Market without Intervention (Inefficient): Conversely, in the presence of positive externalities, a free market tends to underproduce the good or service that provides benefits to third parties. The market quantity (Qm) falls short of the socially optimal quantity (Qs), resulting in underconsumption.
• Diagram:

In both cases, the inefficiency arises because the market does not consider the external costs or benefits. Government intervention, such as taxes for negative externalities or subsidies for positive externalities, can help internalize these external effects and move the market toward a more socially optimal outcome.