Externalities Flashcards
What are externalities?
Externalities may be negative or positive. They are costs or benefits of production or consumption that are external to a market transaction and they impact on third parties, rather than the producer or consumer of a good/service.
What happens when externalities are present?
When they are present, the social cost or benefit of an activity exceeds the private cost or benefit.
Consumption externality
An externality that affects the consumption side of a market which may be either positive or negative.
Negative externalities
exist where the social cost of an activity exceeds the private cost.
What are external costs
costs of production or consumption that fall on innocent third parties, rather than on the producer or consumer of the product.
social cost equation
private cost + external cost = social cost
market failure and negative externalities
The price mechanism allocates resources. Prices are the signals which determine this allocation. However, a misallocation of resources will occur if market prices do not accurately reflect the costs and benefits to society of economic activities. The greater the negative externality, the greater the market failure.
allocative inefficiency
an allocative inefficiency of over production exists, oo many scarces resources are devoted to the production of good/service.
Positive externalities
exists where the social benefit of an activity exceeds the private benefit.
social benefits equation
private benefits + external benefits = social benefits
private benefits
the benefits directly accruing to a particular action
external benefits
the benefits that accrue as a consequence of externalities to third parties
social benefits
the total benefits to society of a particular action
problem of externalities: negative
too many resources will be allocated to production/consumption of that good. We will have an allocative inefficiency of over production/consumption.
problem of externalities: positive
too few resources will be allocated to production or consumption of the product. We will have an allocative inefficiency of under production/consumption.
Negative externalities of consumption analysis
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