externalities Flashcards
what happens when buyers and sellers don’t take into account externalities when deciding how much to consume and produce?
the market fail to be efficient
what are externalities and when do they arise?
usually arise when the actions of the sellers or buyers affect people other than themselves (3rd parties)
externalities are costs or benefits incurred or received by other members of the society but not taken into account by the parties to the market transaction.
what is a negative externality (external cost)?
when the impact on 3rd parties is adverse
what externalities exist?
negative production
negative consumption
positive production
positive consumption
what is a positive externality (external benefit)?
when the impact on third parties is beneficial
what are examples of negative externalities?
negative production;
- air and water pollution
negative consumption;
- cigarette smoking
- loud music
what are examples of positive externalities?
positive production:
- research into new technologies
- new airport
positive consumption;
- education
- immunisations
what do externalities imply?
private benefits/costs diverge from social benefits/costs
what is a social benefit?
the sum of the private benefits resulting from a transaction plus any external benefits (full benefit to society)
what is a social cost?
the sum of the private costs resulting from a transaction plus any external costs (full cost to society)
what makes the market outcome inefficient in the presence of negative externalities?
the price of the good to the buyer does not cover all of the costs of producing or consuming the good.
- if all costs were accounted for, the prices of these goods would be higher and people would consume less of them
what happens in the presence of negative and positive externalities?
negative externalities: markets produce a larger quantity than what is socially desirable/socially optimal (overproduction)
positive externalities: markets produce a lower quantity than what is socially desirable/socially optimal (underproduction)
what makes the market outcome inefficient in the presence of positive externalities?
the producers of the goods do not capture the extra value the good create for others in the price they receive for their goods
- if all benefits were accounted for, the producers would receive a higher price and more of the good would be produced
how can the government counteract underconsumption of positive externality goods?
subsidisation of a good
a well-chosen subsidy can result in a production and consumption level which is closer to (or closer to) the socially optimal level.
such a subsidy would not create a deadweight loss, but would increase welfare
how are positive externalities shown on a graph?
the intersection of the supply curve and the social value determines the optimal quantity of the good for society as a whole.
in the presence of positive externalities, the market equilibrium quantity is too low, compared to the socially optimal level.
