The United Kingdom government is taxing the production of oil in the North
Sea, which will lead to a decrease in production in the oil industry. The production of
oil creates a negative externality and the government is intervening to eliminate the
externality and diminish the impact on the environment. This is an example of
market failure.
Market failure is a situation when market forces result in under- or over-
allocation of scarce resources, resulting in externalities. Oil drilling is a demerit
good which has a negative production externality on the environment. A demerit
good is a good that has a negative impact on society, so the government intervenes
and tries to decrease or prohibit their use. A negative production externality is a
negative effect on society when the marginal social cost (MSC) outweighs the
marginal private cost (MPC). The MPC is the cost of production on the firm. The
