Microeconomics - Positive and negative externalities in consumption and production Flashcards
define externalities
An externality is the cost or benefit a third party receives from an economic
transaction outside of the market mechanism. In other words, it is the spillover effect of the production or consumption of a good or service.
Externalities can be positive (external benefits) or negative (external costs).
Private costs
Producers are concerned with private costs of production. For example, the rent, the cost of machinery and labour, insurance, transport and paying for raw materials are private costs.
This determines how much the producer will supply.
It could refer to the market price which the consumer pays for the good.
Social costs
This is calculated by private costs plus external costs
On a diagram, external costs are shown by the vertical distance between the two
curves. In other words, external costs are the difference between private costs and
social costs.
It can be seen that marginal social costs (MSC) and marginal private costs (MPC)
diverge from each other. External costs increase disproportionately with increased
output.
Private benefit
Consumers are concerned with the private benefit derived from the consumption of
a good. The price the consumer is prepared to pay determines this
Private benefits could also be a firm’s revenue from selling a good
Social benefit
Social benefits are private benefits plus external benefits.
On a diagram, external benefits are the difference between private and social
benefits.
Similarly to external costs, external benefits increase disproportionately as output
increases.
Social optimum position
This is where MSC = MSB and it is the point of maximum welfare.
The social costs made from producing the last unit of output is equal to the social
benefit derived from consuming the unit of output.
draw a positive externality diagram
..
draw a negative externality diagram
..
