Question

4. Give an example of a health economic situation that could be explained by the following graph. Explain carefully the markets to which you are referring to. Negative Externality Creating Deadweight Loss in a Market SMC loss Qs OMKT Quantity

Answer 1

to explain the above graph i am using cigeratte industry. as we all know cigeratte smoking is dangerous to health. it causes cancer and many other health related issues. its worth mentioning the point that its not that the only person who is smoking is being affected by it but the people around that person who are inheling the smoke knowingly or unknowingly are also getting affected adversly. but here the person is buying the cigeratte only at the cost of it and not at the cost of those people who are affected adversly. in these situation the social marginal cost is much higher than the cost that is incurred to produce it. and if the social marginal cost is not added to the price it creates a dead weight loss in the economy, which is depicted in the above diagram.

in the above diagram the cigeratte price is at pmkt and quantity produced is at qmkt which also creates a negative externality. if we add the negative externality and see, the social marginal cost curve will be smc which intersects demand curve at A which increases the price upto ps and reduces the quantity to qs which ultimately creates a deadweight loss of the amount which is denoted by the red tringular area.