Externalities Flashcards
What is an externality
It’s a by-product from production or consumption that affects a third party for which no compensation is paid
Marginal external cost (MEC)
The cost to third parties
Marginal private cost (MPC)
The cost to an individual or firms
Marginal social cost (MSC)
The overall cost to society
Marginal private benefit (MPB)
The benefit to an individual or firm
Marginal external benefit (MEB)
The benefit to third parties
Marginal social benefit (MSB)
The overall benefit to society
What is ideal so there is no allocative inefficiency?
The MSB should be equal to the MSC
What are demerit goods
Demerit goods are those that are socially undesirable creating negative externalities from consumption affecting third parties, the social benefit is less than the private benefit
What happens if demerit goods are left to the market mechanism?
They may be over-consumed
Analyse how can taxation help with demerit goods?
This will increase the price, bringing the externality back into the marker mechanism. The higher price will cause a contraction along the demand curve. Find demand will be closer to the social optimum
Evaluate how taxation can help with demerit goods
— Effectiveness may depend upon the relative elasticity
— May have a regressive effect for those on lower incomes
— May be unfair on those who are consuming responsibly
— Difficult to access the right tax
What is a positive externality?
It’s the same as an external benefit, occurs when the consumption or production of a good causes a benefit to a third party, where the social benefit is greater than the private benefit
What’s a negative externality
It’s the same as an external cost, occurs when the consumption or production of a good causes costs to a third party, where the social cost is greater than the private cost.
Production externality
An externality (which may be positive or negative) generated in the course of producing a good or service.
