1.3.2 Externalities Flashcards
Define externalities
Costs and benefits that affect 3rd parties that are not directly involved in a transaction
What are externalities?
Are a form of market failure, because market forces will not result in an efficient allocation of resources
What are the types of externalities?
- External costs (negative externalities)
- External benefits (positive externalities)
Define private costs
Costs that are paid directly by the producer and consumer in a transaction
Private costs of a producer
Include:
- wages
- rent
- raw materials
- energy
Private costs for a consumer
The cost to the consumer is usually the price paid for the product/service
Define external costs
negative externalities
The costs in excess of private costs that affect 3rd parties who are not part of the transaction
Examples of external costs of production
- Air pollution, e.g. noxious gases from a factory
- Noise pollution, e.g. from building work associated with a new factory or from machinery used in the production process
- Pollution arising from the destruction of the rain forest to grow crops
Examples of external costs of consumption
- Passive smoking, i.e. a non-smoker might suffer from adverse health effects if he/she is in the presence of a smoker over a period of time
- Overeating by individuals: obesity might result in significant costs for the National Health Service and, in turn, taxpayers
Define social costs
The sum of private costs and external costs
Private costs + External costs = Social costs
Define private benefits
benefits that are received directly by the producer and consumer in a transaction
Private benefits to a producer
Include
- revenues received from the sale of the product/service
Private benefits to a consumer
The utility (satisfaction) gained by the consumer from the consumption of the product/service
Define external benefits
positive externalities
The benefits in excess of private benefits which affects 3rd parties who are not part of the transaction
Examples of external benefits of consumption
- Individuals deciding to have vaccinations preventing the spread of diseases to others
- Households with well-kept gardens increasing the market value of neighbouring properties
Examples of external benefits of production
- A farmer who keeps bees to make honey. the bees will benefit surrounding farmers by pollinating their crops
- A firm trains workers in computing skills. Other firms that do not train workers might benefit from employing workers from this firm
Define social benefits
The sum of private benefits and external benefits
Private benefits + External benefits = Social benefits
