CHAPTER 18 • Externalities and Public Goods 667 18.2 Ways of Correcting Market Failure How can the inefficiency resulting from an externality be remedied? If the firm that generates the externality has a fixed-proportions production technology, the externality can be reduced only by encouraging the firm to produce less As we saw in Chapter 8, this goal can be achieved through an output tax Fortunately, most firms can substitute among inputs in the production process by altering their choices of technology For example, a manufacturer can add a scrubber to its smokestack to reduce emissions Consider a firm that sells its output in a competitive market The firm emits pollutants that damage air quality in a neighborhood The firm can reduce its emissions, but only at a cost Figure 18.4 illustrates this trade-off The horizontal axis represents the level of factory emissions and the vertical axis the cost per unit of emissions To simplify, we assume that the firm’s output decision and its emissions decision are independent and that the firm has already chosen its profit-maximizing output level The firm is therefore ready to choose its preferred level of emissions The curve labeled MEC represents the marginal external cost of emissions This social cost curve represents the increased harm associated with the emissions We will use the terms marginal external cost and marginal social cost interchangeably in the discussion that follows (Recall that we have assumed that the firm’s output is fixed, so that the private costs of production—as opposed to pollution abatement—are unchanged.) The MEC curve slopes upward because the marginal cost of the externality gets higher as the externality becomes more extensive (Evidence from studies of the effects of air and water pollution suggests that small levels of pollutants generate little harm However, the harm increases substantially as the level of pollutants increases.) Because our emphasis will be on reducing emissions from existing levels, we will find it useful to read the MEC graph from right to left From this perspective, we see that the MEC associated with a small reduction in emissions from a level of 26 units, which reflects the incremental benefit of reduced emissions, is Dollars per unit of emissions Recall from §7.3 that a firm can substitute among inputs by changing technologies in response to an effluent fee MEC F IGURE 18.4 THE EFFICIENT LEVEL OF EMISSIONS The efficient level of factory emissions is the level that equates the marginal external cost of emissions MEC to the benefit associated with lower abatement costs MCA The efficient level of 12 units is E* MCA E0 10 12 E* 14 16 18 20 22 24 26 E1 Level of emissions