Externalities Flashcards
Externality
A consequence of an industrial or commercial activity which affects other parties without being reflected in the market prices
Externalities notes
-Can be positive or negative
-Can be caused through production or consumption
-Cannot be bought or sold in a market
Positive externality
Occurs when the consumption/production of a good causes external benefit for a 3rd party. e.g. if you walk to work, the community benefits from lower pollution levels. Social benefit>Private benefit
Negative externality
Occurs when the consumption/production of a good causes harm (external cost) to a 3rd party. e.g. playing loud music at night will keep your neighbour awake. Social costs>Private costs
Key terms
External cost-Third party cost (pollution)
External benefit-Third party benefit (education)
Private cost-Cost to individual/firm (labour, capital etc)
Private benefit-Benefit to individual/firm (subsidy-receiving)
Social costs/benefits
Social costs(total cost to society)=Private + external costs
Social benefits(total benefit to society)=Private + external benefit
Free rider
Provider of the positive externality (e.g. a beautiful view) cannot charge a market price to any willing free-riders who enjoy it. Also free riders who receive a negative externality (e.g. pollution) cannot charge a price to the polluter for the result they are forced to consume.
Negative externalities notes
-Usually results in overproduction
-Social costs increase with higher output (e.g. more pollution as you produce more) so goods with negative externalities are overproduced when only private costs are considered in decisions
Positive externalities notes
-Usually results in underproduction
-Social benefits increase with higher outputs (e.g. more vaccinated means less risk of infections for others.) Vaccines are underproduced when only private benefit is considered, not social benefit.
