Pollution

Socially optimal level of pollution

Society derives some indirect utility from pollution, otherwise there would be no incentive to pollute. This utility comes from the consumption of goods and services that create pollution. Therefore, it is important that policymakers attempt to balance these indirect benefits with the costs of pollution in order to achieve an efficient outcome.

A visual comparison of the free market and socially optimal outcomes.

It is possible to use environmental economics to determine which level of pollution is deemed the social optimum. For economists, pollution is an “external cost and occurs only when one or more individuals suffer a loss of welfare,” however, there exists a socially optimal level of pollution at which welfare is maximized. This is because consumers derive utility from the good or service manufactured, which will outweigh the social cost of pollution until a certain point. At this point the damage of one extra unit of pollution to society, the marginal cost of pollution, is exactly equal to the marginal benefit of consuming one more unit of the good or service.
In markets with pollution, or other negative externalities in production, the free market equilibrium will not account for the costs of pollution on society. If the social costs of pollution are higher than the private costs incurred by the firm, then the true supply curve will be higher. The point at which the social marginal cost and market demand intersect gives the socially optimal level of pollution. At this point, the quantity will be lower and the price will be higher in comparison to the free market equilibrium.^[32] Therefore, the free market outcome could be considered a market failure because it “does not maximize efficiency”.
This model can be used as a basis to evaluate different methods of internalizing the externality. Some examples include tariffs, a carbon tax and cap and trade systems.