Answer to Question #48334 in Economics for Jael

Question

Consider the following scenario: The city council has just approved the construction of a water park in your town. You are responsible for studying the impact of the new water park on the local economy and the surrounding community.
Write a paper of approximately 500 words that addresses the questions below.
You know that the water park will increase the traffic flow in the streets around the water park. There are both businesses and neighborhoods adjacent to the increased traffic flow. The cost to the community is estimated to be $6 per person. What kind of externality is this? Why?
Graphthe market for water park business, labeling the demand curve, the social-value curve, the market equilibrium level of output, and the efficient level of output.
What is the per-unit amount of the externality?
You know that the water park will have events in the evening. This will increase both foot traffic and street traffic at night. You believe this will improve the safety of the surrounding businesses, with an estimated benefit of $3 per water park attendee. What kind of externality is this? Why?
Create a new graph illustrating the market for water park business for these two externalities. Label the demand curve, the social-value curve, the market equilibrium level of output, and the efficient level of output.
What is the per-unit amount of both externalities?
Discuss both government and private solutions that would result in an efficient outcome.

Answer 1

It is a kind of negative externality, because people, who live near water park, have costs from the increased traffic.
A negative externality occurs when an individual or firm making a decision does not have to pay the full cost of the decision. If a good has a negative externality, then the cost to society is greater than the cost consumer is paying for it. Since consumers make a decision based on where their marginal cost equals their marginal benefit, and since they don't take into account the cost of the negative externality, negative externalities result in market inefficiencies unless proper action is taken.
When a negative externality exists in an unregulated market, producers don't take responsibility for external costs that exist--these are passed on to society. Thus producers have lower marginal costs than they would otherwise have and the supply curve is effectively shifted down (to the right) of the supply curve that society faces. Because the supply curve is increased, more of the product is bought than the efficient amount--that is, too much of the product is produced and sold. Since marginal benefit is not equal to marginal cost, a deadweight welfare loss results.