1.3.2 Externalities Flashcards
Externalities
The effects that producing or consuming a good/service has on third parties.
What are positive externalities?
The external benefits to society.
What are negative externalities?
The external costs to society.
Example of positive externality of production
Bees pollinating plants
Example of negative externality of production
Pollution from burning of fossil fuels
Example of positive externality of consumption
Vaccines
Example of negative externality of consumption
Litter
Social cost
A cost experienced by a 3rd party as a result of the consumption of a product or service by another individual.
Private cost
A cost experienced by the individual/firm that has consumed the product or service.
Social benefit
A benefit experienced by a 3rd party as a result of the consumption of a good/service by another individual.
Private benefit
A benefit experienced by the individual/firm that has consumed the good/service.
Example exernalities diagram
Key labels on the externalities diagram
MPC = Marginal Private Cost
MSC = Marginal Social Cost
MPB = Marginal Private Benefit
MSB = Marginal Social Benefit
Qe = Quantity equilibrium
Equilibrium Point on the Externalities Diagram
When supply and demand are equal, there is an equilibrium point in the free market.
In a free market, consumers and products only consider their private costs and private benefits – they ignore any social costs or benefits. As a result, the MPC curve can be seen as the supply curve of a good/service and the MPB curve can be seen as the demand curve.
So equilibrium occurs when MPC = MPB.
Where is the socially optimum level of output on an externalities diagram?
The socially optimum level of output is where MSC = MSB.