Using diagrams and an example, define what is meant by the term "negative externality of consumption". List two policies that can be used to correct for this market failure.
Cannabis is a demerit good, which is defined as goods that are socially undesirable and have negative externalities; therefore the MPB of consumption is greater than the MSB. In a free market, cannabis is over consumed at Qp. The amount of negative externality, defined as a cost that is suffered by a third party as a result of an economic transaction, is indicated on the diagram 1 as the difference between the MPB and MSB curves, whilst the shaded triangle shows welfare loss. Qp is greater than Qs, leading to market failure, which occurs when the market fails to deliver an efficient or optimal allocation of resources. The government aims to shift the MPC curve leftwards until the point where MSB = MSC, reaching the socially optimum level of output at Qs. They can do this through several policies: taxation (which shifts the supply curve upwards by the amount of the tax) and negative advertising (which decreases the demand for cannabis).
