Negative Externality Of Production

1. Negative Externality Of Production

2. Negative Externality of Production: • The unintended side effects result from production • Society face the negative spill over cost resulting from firms’ production. In New Zealand, an example of negative externality of production is cutting down native trees. Cutting down native trees will cause events such as erosion, flooding and landslides, which are the negative spill over cost. Negative externality of production can be represented in the graph below: Society faces negative spill over cost when Government uses taxpayers money to repair damages result from landslides, flooding and erosion.

3. Total Gain from Trading (TGT) unable to cover entire spill over cost so create dead weight loss (DWL). It can be shown in the graph below: Graph : Negative Externality of Cutting Down Native Trees Consumers’ Surplus (at Social Equilibrium) SMC Cost/Revenue PMC Dead Weight Loss Social Equilibrium Total Gain from Trading (TGT) Producers’ Surplus (at Social Equilibrium before Government intervention) Consumers’ Surplus (at Free Market) PS Free Market Equilibrium PFM Negative Spill over Cost PMB = SMB QS QFM Output Producers’ Surplus (at Free Market)

4. Dead weight loss could be eliminated when Government intervenes the free market. There are two fiscal policies the Government could implement. They are imposing sales tax on timber and introduce the Resource Management Act (RMA). • Effectiveness of Imposing Sales Tax on timber: • On consumers: • Increase the price consumers need to pay • from P to PCON = P1 • Makes timber relatively less affordable • Decrease quantity demand from Q to Q1 • On producers: • Decrease the price producers receive from P • to PPR • Decrease producers profitability level • Producers cut down less native trees (cut • production) • Decrease quantity supply from Q to Q1 Market for Timber Price STAX (=SMC) S (=PMC) PCON = P1 P PPR D Q1 Q Quantity Decrease quantity demand and decrease quantity supply bring market back to social equilibrium (PCON = P1 = Q1) and so the DWL is eliminated

5. Equity of Imposing Sales Tax on Timber: • On consumers: • It will mainly affect low income earners the high income earners • Decrease the purchasing power of the low income earners as they now need to spend a • greater portion of their income to buy the timber they desire • Therefore imposing tax on timber is not vertically equitable • On producers: • It will affect all producers cutting down native trees • Producers with good practices need to pay same amount of tax to the Government as • those producers who are not using good practices • Therefore imposing tax on timber is not horizontally equitable Based on these, it shows that imposing sales tax is neither horizontally equitable nor vertically equitable policy

6. Resource Management Act (RMA) regulates access to natural and physical resources such as land, air and water with sustainable use of these being the overriding goal. • Effectiveness of Introducing RMA: • On producers: • Producers restricted from using the land • Producers to apply resource consent from • Government • Producers to show their ability of implementing good practices, sustain the land and pay a fee to Government • Increase producers cost of production from P • to P1 • Decrease producers profitability level • Producers cut down less native trees (i.e. cut • production) • It causes the supply to decrease from • S (=PMC) to S1 (=SMC=PMC1) • Market operating at social equilibrium • (SMC = SMB) • Eliminates DWL (i.e. market allocating • resources efficiently) Market for Timber Price S1 (=SMC=PMC1) S (=PMC) PS = P1 P D (=PMB=SMB) Q (QFM) Q1 (QS) Quantity

7. Equity of Introducing RMA: • On consumers: • It will mainly affect low income earners the high income earners • Consumers bid timber price up to secure the timber they desire • Decrease the purchasing power of the low income earners as they now need to spend a • greater portion of their income to buy the timber they desire • Therefore introduction RMA is not vertically equitable • On producers: • It will mainly affect those producers (cutting down native trees) who do not have good • practices • Producers without good practices will be review and declined by Government at worst when • applying for resource consent (i.e. tougher assessment and more restrictions from • Government) • Those producers with good practices will have less impact from RMA • Producers able to get consent easier as they are already obeying the regulations set in RMA • Therefore introducing RMA is horizontally equitable Based on these, it shows that introducing RMA is horizontally equitable but not vertically equitable policy

8. Government intervention brings the market back to equilibrium (new social equilibrium): After Government intervention (i.e. imposing sales tax on timber & introducing RMA), DWL will be eliminated and it can be shown in the graph below. Graph : DWL been eliminated after Government intervention Consumers’ Surplus (at Social Equilibrium) SMC Cost/Revenue PMC Dead Weight Loss Social Equilibrium Producers’ Surplus (at Social Equilibrium before Government intervention) PS Free Market Equilibrium PFM Negative Spill over Cost PMB = SMB QS QFM Producers’ Surplus (at Social Equilibrium after Government intervention)

9. CONCLUSION: • I would recommend the Government to introduce RMA • Because: • RMA is relatively more equitable policy (i.e. horizontally equitable • but not vertically equitable) than imposing sales tax • RMA will restrict producers with bad practices from using the land to • cut down native trees. • It protect land for the future and not imposing any addition cost on • consumers in the short term • I would not recommend the Government to impose sales tax on timber • Because: • It is not equitable policy (i.e. neither horizontally equitable nor • vertically equitable) as it affect both low income earners as well as • producers with good practices Therefore introducing RMA would be a better policy to be implemented than imposing sales tax on timber

10. THE END !THANK YOU! BY: SHAUN YOON (13 BRC) FOR: 13 ECONOMICS UNIT STANDARD 10928