Externalities

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Intros
Lessons
  1. Externalities Overview
  2. Externality Definition & Types
    • Definition of Externality
    • Positive & Negative Externality
    • Positive & Negative Production Externalities
    • Positive & Negative Consumption Externalities
  3. Private, External, Social Cost
    • Private & Marginal Private Cost
    • External & Marginal External Cost
    • Social & Marginal Social Cost
    • Marginal Social Cost (MSC) = MC + Marginal External Cost
  4. Effects of Negative Externalities
    • Marginal External Cost & Marginal Social Cost
    • Market Equilibrium
    • Socially Optimal Output
    • Overproduction of output
    • Deadweight Loss from Overproduction
  5. Benefit, & Social Benefit
    • Positive Externalities
    • Private Benefit & Marginal Benefit
    • Social Benefit & Marginal Social Benefit
  6. Effects of Positive Externalities
    • Market Equilibrium
    • Socially Optimal Output
    • Underproduction of Output
    • Deadweight Loss from Underproduction
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Examples
Lessons
  1. Negative externalities create a ________, and positive externalities create a __________.
    1. Benefit, benefit
    2. Benefit, cost
    3. Cost, benefit
    4. Cost, Cost
  2. Which is not an example of negative consumption externality?
    1. Smoking cigarettes in public.
    2. Creating a product that creates pollution.
    3. Littering.
    4. Not cleaning up household wastes.
    5. None of the above.
  3. Questions Relating to Marginal Private/Social Benefits & Costs
    The following table shows the marginal benefits that Sam and Devin receive from police officers on duty during work hours at their firm.

    Police officers on duty

    (number of days)

    Marginal Benefit

    Sam

    Devin

    1

    25

    30

    2

    20

    25

    3

    15

    20

    4

    10

    15

    5

    5

    10


    If Sam and Devin are the only people at work, then graph the marginal social benefit.
    1. The following table provides costs and benefits that occur from a firm production that pollutes a lake used by fishers.

      Output of production

      Marginal cost

      Marginal external cost

      Marginal social benefit

      0

      0

      0

      150

      1

      5

      15

      125

      2

      15

      30

      100

      3

      30

      45

      75

      4

      50

      60

      50

      5

      75

      75

      25
      1. If no one owns the lake and there are no regulations for pollution, then what is the quantity of pollution produced and marginal cost of pollution?
      2. If the fishers own the lake, then what is the quantity of pollution produced?
    2. The following table provides costs and benefits in a society for a certain production.

      Output of production

      Marginal social cost

      Marginal private benefit

      Marginal external benefit

      0

      0

      30

      45

      1

      5

      25

      40

      2

      10

      20

      35

      3

      15

      15

      30

      4

      20

      10

      25

      5

      25

      5

      20
      1. Graph the MSCMSC, MPBMPB, and MSBMSB.
      2. If only you make use of the product, what would be the quantity of output produced?
      3. If the entire society makes use of the product, what would be the quantity of output produced?
      4. What is the deadweight loss if only you made use of the product?
    3. The follow table shows the data on a wildlife anti-extinction program.

      Output of Fences

      Marginal Social

      Cost

      Benefit

      1

      3

      15

      2

      6

      12

      3

      9

      9

      4

      12

      6

      5

      15

      3
      1. What quantity of fences would a private wildlife anti-extinction program provide?
      2. What is the efficient quantity of fences?
      3. If the government decides to appoint someone to run the wildlife anti-extinction program, would fences be underprovided, overprovided, or provided at the efficient quantity?
    Topic Notes
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    Externality Definitions & Types

    Externality: A cost or benefit from a production that affects the well-being of another person, but is not compensating or being compensated for what the production did.

    Within externalities, there is
    1. Negative externality: this creates a cost
    2. Positive externality: this creates a benefit

    Externalities are also known as spill overs onto third parties.

    There are four types of externalities
    1. Negative Production Externalities: Clearing forests destroys habitat of wildlife and adds more carbon dioxide to the atmosphere.
    2. Positive Production Externalities: Beekeepers keeping bees for their honey. The positive externality would be the pollination from surrounding crops by the bees.
    3. Negative Consumption Externalities: Smoking cigarettes pollutes the air around you and imposes a health risk to others.
    4. Positive Consumption Externalities: Maintaining an attractive house can increase the market price for houses around your neighbourhood.

    Private, External, Social Cost

    Now lets investigate negative externality.

    Private Cost of Production: cost incurred by the producer of a good or service .

    Marginal Private Cost (MC) : Additional private cost gained from a one-unit increase in production of a good or service.

    External Cost of Production : a cost that is not incurred by the producer but incurred by other people.

    Marginal External Cost : Additional external cost gained from a one-unit increase in production of a good or service.

    Social Cost of Production : Total cost to society resulting from productions made by individuals and firms.

    Marginal Social Cost (MSC) : cost incurred by the entire society from a one-unit increase in production.

    Effects of Negative Externalities

    Suppose we have the demand curve and the private MC curve. The market equilibrium would be the intersection of those two curves.

    Effects of Negative Externalities demand curve and the private MC curve

    However, they are externality costs not covered by the firms, and incurred by others. Taking those into account, we graph the MSC curve.

    Effects of Negative Externalities externality costs not covered by the firms, and incurred by others

    Therefore, the intersection between the MSC and Demand curve is the socially optimal output.

    Note: Since Q1 > Q2, we have an overproduction, thus a deadweight loss.

    Private Benefit, & Social Benefit

    Now lets investigate positive externality.

    Marginal Private Benefit: The demand curve which does not take external benefit into account.

    Marginal Social Benefit: A curve that takes all the benefits into account.

    positive externality Private Benefit, & Social Benefit Marginal Social Benefit

    Effects of Positive Externality

    Suppose we have the demand curve (MPB) and the MSC curve. The market equilibrium would be the intersection of those two curves.

    Effects of Positive Externality demand curve (MPB) and the MSC curve


    However, they are externality benefit not covered. Taking the external benefit into account, we graph the MSB curve.

    Effects of Positive Externality they are externality benefit not covered


    Therefore, the intersection between the MSB and MSC is the socially optimal output.

    Note: Since Q2>Q1, we have an underproduction, thus a deadweight loss.