The basic supply-demand model can help to explain the externalities analysis of environmental problems and its implication for public policy.
As an illustration, we should be dealing with the problem of solid wastes and the damage that the massive generation of garbage is doing to our environment.
In the figure below, we have a demand curve DE for waste disposal. Just like a normal demand curve it has a negative slope. Meaning that if the price of garbage removal is set sufficiently high, people will become more careful about the amount of garbage they produce. They will begin to demand less elaborate packaging on the goods they buy. They will repair broken items, rather than throw them out, etc.
Whether wastes are solids, liquid or gaseous, they impose costs upon the community. If the emitter is not charged for the damage, it is as though the resulting wastes were removed with zero charges to the polluter.
The polluter is then induced to emit a great deal (25 million tons in the figure above). If the charges to him reflected the true costs to the community, supply curve SS of waste removal, it will pay to emit a much smaller amount(10 million tons) in the figure. Thus, if the suppliers have to pay the full cost of garbage removal, the supply curve would be comparably high as shown above, and with a positive slope, meaning that the unit cost of garbage disposal rises as quantity rises. Here the price for garbage removal is P Naira per ton and at that price 10 million tons will be generated (point A).
But if the municipal government decides to remove garbage free, this of course means that government is really charging the consumers for the service in the form of taxes, but not in a way that makes each consumer pay an amount that reflects the quantity of garbage that the consumer produces. This will result in the supply curve SS becoming the real IT; which lies along the horizontal axis.
What this means is that any one household can increase the quantity of garbage it throws away as much as it wishes, and still pay a zero price for the additional amount.
Now the intersection of the demand and supply curve is no longer at point A, but point E at which the quantity of garbage generated is 25 million tons, an amount substantially greater than would be produced if those who make the garbage have to pay the cost of getting rid of it.
Similar problems occur, if the national, state or local governments offer the oxygen of its water ways and the purity of its atmosphere at a zero price, to all who choose to utilise them. However wasteful and however great the quantities they decide to use up, the amount that would be wasted and otherwise used up is likely to be enormously greater than it would be if users have to pay for the cost of their activities to society.
In the views of the economist, it is the major reason for the severity of our environmental problems. From the above analysis we can draw some conclusions that:
(i) The magnitude of our pollution problems is attributable in large part to the fact that the country lets individuals, firms and government agencies deplete without financial charge, such resources as oxygen in the water and pure air.
(ii) One way of dealing with pollution problems is to charge those who emit pollution and who cause other sorts of environmental damage, a price commensurate with the cost they impose on the society.
(iii) This is another instance in which higher prices on environmentally damaging activities can be beneficial to the community.