Externalities Flashcards
What are externalities
Spill over effects from production and/or consumption for which no appropriate compensation is paid to one or more third parties affected
What can externalities cause
Marker failure is the price mechanism does not take into account of the social costs and benefits of production and consumption
What can externalities be
Positive and/or negative
What are private costs
Costs faced by the producer or consumer directly involved in a transaction
What happens when negative externalities exist
Social costs exceed private cost
Equation for social costs
Social cost = private cost + external cost
What are external costs
When the activity of one agent has a negative effect on the wellbeing of a third party
Useful evaluation point
Virtually impossible to put a price on externalities
What is MPC and explain it
Marginal Private Cost
Cost to the producer or to an individual of producing an additional unit of output
What is MEC and explain it
Cost to third parties form the production/consumption of an additional unit of output
What is MSC and explain it
Marginal Social Cost
Total cost to society of producing an extra unit of output
MSC = MPC + MEC
What is MEB and explain it
Marginal external benefit
The benefit to a third party from the production / consumption of an additional unit of a good or service
What is MPB and explain it
Marginal Private Benefit
The benefit to the producer of an individual to producing an additional unit of output
What is MSB and explain it
Marginal Social Benefit
Total Benefit to society from consuming an extra unit
MSB = MPB + MEB
When does negative externalities occur
When social costs exceed private cost
When do external costs occur
When the activity of one agent has a negative effect in the well-being of a third party
What do external costs do
Damage third parties - consumer and producer don’t have to pay
Market output will be too high
When does deadweight loss of social welfare occur
MSC > MPC
When do positive externalities exist
When third parties benefit from spill over effects of production/consumption
What happens in positive externalities in production
MSC of Production < MPC of Production
What is private optimum consumption
MPB = MPC
What is social optimum consumption
MSB = MSC
What is market failure
Too much or too little of a good is produced and/or consumed - compared to socially optimal level of output
Price mechanism leads to an inefficient allocation of resources
What are types of market failure
Externalities
Public Goods
Information Gaps
