4.1.8.4 Positive and negative externalities in consumption and production Flashcards
When do externalities exist ?
when there is a divergence between private and social costs and benefit
Why are negative externalities likely to result in over-production ?
Negative externalities are caused by demerit goods. These are associated with information failure, since consumers are not aware of the long run implications of consuming the good, and they are usually overprovided.
Why are positive externalities likely to result in under-production ?
Positive externalities are caused by merit goods. These are associated with information failure too, because consumers do not realise the long run benefits to consuming the good. They are underprovided in a free market.
Production externality
an externality generated in the course of producing a good or service
Consumption externality
an externality generated in the course of consuming a good or service
social benefits
the total benefit of a particular action. Private benefit + external benefit.
Private benefit
those benefits that are incurred by individuals who produce or consume a good or service
Social costs
the total cost of a particular action.
Private cost + external cost.
Private costs
those costs that are incurred by individuals who produce or consume a good or service.
Social optimum position: iwhere
where MSC = MSB and it is the point of maximum welfare.
The social costs made from producing the last unit of output is equal to the social benefit derived from consuming the unit of output.
When do markets become inefficient?
When there is no property rights
What does the moral hazard assume ?
moral hazard assumes someone else will pay the consequences for a poor choice.
For example, some people might litter the street if they think that other people will clear up after them
Dealing with positive externalities
Rules and regulations – minimum school leaving age
Increasing supply – the government building of council housing to increase the stock of good quality housing.
Subsidy to reduce price and encourage consumption, e.g. government subsidy for rural train services.
Externality of the housing market
Therefore, the social benefit of good quality housing can be greater than the private benefit that property developers gain.
Positive externality in the housing market: social problems
Good quality housing helps to reduce social problems, such as drug use, crime and vandalism. Poor quality, high-density housing (e.g. 1960s tower blocks) were associated with various social problems, such as increased crime rates. This type of housing may be cheap to build, but investing in better quality housing with more features, such as gardens can create a better environment which helps to improve social welfare and strengthen local communities.
Positive externality in the housing market: public health
Better public health. In extreme cases ‘slum’ housing with poor sanitation and damp surroundings can contribute to ill health. Building better housing without damp and with better sanitation can lead to improved public health which is an external benefit to society.
Positive externality in the housing market: environmental standards
If houses are built with high levels of insulation, then they will help reduce the environmental costs of heating. This is an external benefit because society benefits from an improved environment related to the building of insulated housing.
Positive externality in the housing market: mobility
Building new houses can also increase geographical mobility and provide benefits to local business and employers struggling to employ sufficient people.
Market failures in housing
Homelessness – but empty housing
Expensive cost of housing and inequality.
Geographical immobility (regional difference in house prices)
Boom and bust in house prices and effect on macroeconomy
Housing as merit good – social problems (crime and vandalism) arising from lack of sufficiently good quality housing.
Environmental costs of building new houses.
Geographical immobility in the housing market
Due to the divergence between house prices in the north and south, it can be difficult for workers to find suitable accommodation in London. Therefore, this leads to a shortage of key skilled workers in areas of very expensive house prices. For example, London schools and hospitals are experiencing staff shortages – partly caused by the housing market.
It is difficult for firms to relocate and it is difficult to build houses in the expensive cities.
Merit good in the housing market
Housing could also be seen as a type of merit good with positive externalities for the rest of society. If housing is of a poor standard (e.g. overcrowding, unsanitary conditions) it can contribute to social problems such as rioting, crime, unemployment and vandalism. Well maintained housing provides conditions more amenable to reducing these social problems.
Negative externalities
Negative externalities occur when the consumption or production of a good causes a harmful effect to a third party.
Examples of negative externalities
Loud music. If you play loud music at night, your neighbour may not be able to sleep.
Pollution. If you produce chemicals and cause pollution as a side effect, then local fishermen will not be able to catch fish. This loss of income will be the negative externality.
Congestion. If you drive a car, it creates air pollution and contributes to congestion. These are both external costs imposed on other people who live in the city.
Building a new road. If you build a new road, the external cost is the loss of a beautiful landscape which people can no longer enjoy.
Negative production externality
When producing a good causes a harmful effect to a third party. Therefore the social cost is greater than the private cost
