The emission of pollution by a firm into the atmosphere or into a river may be economically inefficient because air or water pollution would have very harmfully effects such as cancer, acid rain, global warming etc on society, plants and on animals. Firms that emits pollution into the environment usually don't account for this in their costs of production, whereas society is obligated to the pay the costs of dealing with this pollution problem. Therefore, the pollution emitted by the firm is a negative externality, as negative externality occurs when the social cost is greater than the private cost. How the effects of negative externalities can lead to an economically inefficient allocation of resources is illustrated in figure 1 below. In figure 1, the demand curve DD is for a particular commodity and the supply curve SS reflects only private cost of production. When the cost of externalities is included, the supply curve shifts to left to S1S1 and the equilibrium price is increased to P1. What this implies, is that there is a different allocation of resources, since consumer demand less of this commodity and prefer resources to be used as production alternatives. Therefore in a free market there would be an over consumption of this commodity in relation to the optimal level.
            
            
             Evaluate two ways of reducing any economic inefficient caused by pollution:
             One of the ways of reducing economic inefficiency caused by pollution is to impose a tax on the polluter in proportion to the amount of pollution generated. For example if a factory which emits smoke pollution as a result of producing good sugar, then those living in the area of the factory will experience a negative externality because the air around the factory is polluted. The effects of this problem can be seen in the graph below. If DD is the demand for sugar and SS is the supply curve when only private costs are measured, and the market was free of any government inte...