1.3.2 - Externalities Flashcards
What are externalities?
A externality is a spill over effect from the production and or consumption for which no appropriate compensation is paid to 3rd parties affected, impacts on third parties.
Externalities are not reflected in the market price. Externalities cause market failure if the price mechanism does not take social costs and benefits of production.
What are private costs?
Private costs are the costs faced by the producer or consumer directly involved in a transaction.
What are external costs?
External costs are the costs imposed on 3rd parties as a result of transactions that they are not directly involved in.
What are social costs?
Social costs are private costs + external costs
What are the costs when negative production occurs?
When negative (production) externalities exist social costs exceed private costs.
External costs occur when the activity of one agent has a negative effect on the wellbeing of a 3rd party, they damage 3rd parties but consumers and producers don’t have to pay meaning output will be too high.
What are Marginal social external and private costs?
Marginal private costs (MPC): Cost to the producing firm of producing an additional unit of output to an individual of any economic action.
Marginal external costs (MEC): Costs to 3rd parties from the production of an additional unit of a good.
Marginal social costs (MSC): Total costs to society of producing an extra unit of output MSC = MPC + MEC
Used when drawing externality diagrams considering one or more unit of consumption.
What does negative production look like on a diagram?
If there is negative externalities must add external cost to the firms supply curve illustrated by the orange area.
If market fails to include external costs the equilibrium is Q1 P1 where MPC = MPB
The socially optimum point is Q2 P2 higher price. At this price level external costs are taken into account and so MSC = MSB
The externality has not been eliminate but the market has recognised it and priced it into the product.
How is the welfare loss shown on a negative externality diagram?
The welfare loss refers to the total value of undesired negative externalities as a result of the over production occurring in this market.
What are positive externalities?
Positive externalities exist when 3rd parties benefit from the spill over effects of production/consumption.
What are private benefits?
Private benefits are the benefits faced by the producer or consumer directly involved in the transaction.
What are external benefits?
External benefits are the benefits enjoyed by the 3rd parties as a result of a transaction that they are not directly involved in.
What are social benefits?
Social benefits are private benefits plus external benefits.
Therefore positive externalities exist when social benefits exceed private benefits. External benefits occur when the activity of one agent has a positive effect on the wellbeing of a 3rd party.
External benefits are good for 3rd parties but consumers and producers don’t take this into account output will be low in case of positive consumption externalities the market price will be high.
What are Marginal private, external and social benefits?
Marginal private benefits (MPB): Benefits to the consumer of consuming an additional unit of a good.
Marginal external benefits (MEB): Benefit to 3rd party from the consumer consuming an additional unit of output
Marginal social benefits (MSB): Total benefit to society of consuming an extra unit of output MSB = BPB + MEB
Positive externalities mean MSB are greater than MPB
