Positive & Negative Externalities

When do externalities occur?

When there is an external impact on a third party not involved in the economic transaction.

• This can be on the production or consumption side

What is a Private Cost in an economic transaction?

The direct cost paid by the individuals or firms actually involved in the trade.

Producer: Wages for workers, the price of raw materials

Consumer: The $\$5$ you pay for a coffee

What is the External Cost in an economic transaction?

The damage not factored into the economic activity

e.g generating pollution

What is Social Cost equal to?

Private cost + external cost = social costs

When do external costs occur?

Social Costs > Private Costs

When the social costs of an economic transaction are greater than the private costs

What is a Private benefit in an economic transaction?

It is the internal value that stays with the buyer or the seller, without considering how it affects the rest of the world.

ie. What they actually Gain

What is the External Benefit in an economic transaction?

The benefit not factored into the economic activity

e.g a law student enjoys private benefits but society benefits from having strong legal institutions

What is Social Benefit equal to?

Private benefit + external benefit = social benefits

When do External Benefits occur?

Social Benefits > Private Benefits

When the social benefits of an economic transaction are greater than the private benefits

What are Negative Externalities Of Production?

Externalities caused by producer supply and result in a negative external impact on a third party.

Why will firms over-produce goods/services with negative externalities?

Because Only the private costs are considered by producers and not the external costs. This leads to market failure

• if the external costs were considered, the quantity of goods and services produced would decrease and they would be sold at a higher price

What are Negative Externalities of Consumption?

Externalities that are often created during the consumption of a good/service

• the externalities are caused by consumer demand and result in a negative external impact on a third party

Why will individual over-consume Negative Externalities of Production?

As only the private costs are considered by consumers and not the external costs, individuals will over-consume these goods and services, causing a market failure.

• If the external costs were considered, the quantity of goods and services demanded would decrease, and they would be sold at a lower price

What are positive externalities of production?

Positive externalities created during the production of a good/service

• these externalities are caused by producer supply and result in a positive external impact on a third party.

Why are these Positive externalities of production under-provided?

As only the private benefits are considered by the producers and not the external benefits, causing market failure

• if the external benefits were considered, the quantity of goods/services produced would increase, and they would be sold at a lower price

What are positive externalities of consumption?

Positive externalities created during the consumption of a good/service

• these are caused by consumer demand and result in a positive external impact on a third party

Why are these Positive externalities of consumption under-consumed?

As only the private costs are considered and not the external costs, individual will under-consume these goods/services causing market faliure

• if the external benefits were considered, the demand would increase, and the goods would be sold at a higher price.