The graph above represents the tobacco industry. Answer the next questions using this graph.   4.1. Does the industry create a negative or positive externality? Briefly explain.  4.2. Without any government intervention, what are the equilibrium price and quantity?  4.3. What are the socially optimal price and quantity?  4.4. Give an example of a policy that can be applied in order to eliminate the externality in this market.

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Market Failure Analysis

To understand Market failure, we need to first understand welfare economics. An Italian economist, Vilfredo Pareto stated that allocation of resources in an efficient manner such that an economic change, which harms no one and makes someone better off, indicates an increase in social welfare. It is also called Pareto Optimality, where resources cannot further be reallocated without harming one. This does not apply to those economic changes, which harm some and benefit others. social welfare increases if the utility of any of its members' increases and none decrease in the economy.