1.3.2 Externalities Flashcards
What are externalitites?
Externalities are either a cost or benefit to a thrid party as a result of consumption or production
What is the difference between social costs and private costs?
Private costs are the costs of the firm however social costs are the private costs + external costs. If external costs are positive then MSC>MPC.
Define negative production externalites
A cost to a third party from the production of a good or service by firms. For example, flight services and flights taking off may cause for noise pollution for locals thus a negative production externality and MSC>MPC.
How can a negative production externality curve be analysed?
MSC>MPC creating new equilbrium price point which is higher however the market/firms are not producing at this new social optimum where MSC=MSB and as a result are over producing and selling at too low of a price causing for over consumption. Therefore resources are being misallocated as firms are acring in their best self interest causing allocative ineffiency hence market failure.
This creates a welfare loss within economy
Define negative consumption externality
This is where there are costs to a third party as a result of the consumption of a good/service by consumers. E.g smoking in public will casue bystanders to inhale the smoke (passive smoking) thus the external benefit is negative causing MPB>MSB.
How may a negative consumption externality be analysed on a diagram
MPB>MSB and the market/firms are operating at where MPB=MPC however should be operating at the social optimum where MSB=MSC. As a result the market is overproducing causing misallocation of resources as consumers are acting in their own best self interest. The misallocation of resources means allocative ineffiencey thus creatin market failure as and a welfare loss.
Define posititve consumption externality
This is where MSB>MPB due to external benefits being postitve. For example indivduals consumong healthy foods means less time needed to be spent off work due to greater health so can be more productive and increase firms productivity.
How may a positive consumption externality curve be analysed?
MSB>MPB however markets are operating where MPB=MPC although should be operating at the social optimum where MSB=MSC. As a result of markets not operating at the social optimum there is under consumption and production as consumers are acting in their own self interest of private benefits despite being unaware of the positive external benefits. Therefore the underconsumption and production causes for the net social welfare to not be maximised. The misallocation of resources and allocative ineffiency results in market failure as well as a welfare loss.
Define postivie production externality
Positive production externality is a benefit to a third party as a result of the production of a good or service. E.g in training schemes to help increase human capital of workers, other firms can then poach these workers and as a result only have to pay high wages instead of the training scheme itself too.
How may a positive production externality curve be analysed
MPC>MSC as external costs are negative however market is operating at the private optimum where MPC=MPB but should be operating at the social optimum where MSC=MSB . Therefore there is underproduction and underconsumption meaning net social welfare is not being maximised. Resources are being misallocated creating allocative inefficiency thus market failure. Welfare loss is created from net social welafre not being maximised.
What are common themes in externalitites.
1) Markets operate at private optimum as economic agents act in their own best self interest.
2) In externalitites welfare loss is always created as its a type of market failure.
3) Negative externalities tend to have overconsumption and production whilst positive externalitites have underconsumption and production
5) Positive externalitites fail to maximise net social welfare as economic agents act in self interest.
