1.3.2 - Externalities

What are demerit goods?

A good that can have a negative impact on the consumer

What is a social cost?

A social cost is the cost of production or consumption of a product for soviet as a whole

What is the formula for social cost

Social cost = private cost + external cost

What is a private cost

A private cost is a cost that is experienced by the individual / firm directly involved in the economic transaction

What is an external cost?

An external cost is a cost experienced by third parties as a result of consumption of a good or service by another individual

What are externalities

Externalities are the third party effect from production and consumption of goods and services

Explain this diagram

• Deadweight welfare cost - the reduction of economic efficiency that occurs when the market is not in equilibrium

• Extra units produced beyond Q* imposes an additional cost on society

• MSC - marginal social cost

• MPC - marginal private cost (supply curve in a free market)

• MSB = MPB - marginal social benefit - marginal private benefit

• Qe - free market equilibrium and it leads to over production

• Q* - socially optimal output

• With negative externalities social cost > private cost

Explain this diagram

• Qe - free market equilibrium and because they don’t know the value of the goods, they are under provided or under consumed which leads to market failure

• With positive externalities of consumption social benefit > private benefit