3.1.5.4 POSITIVE AND NEGATIVE EXTERNALITIES IN CONSUMPTION AND PRODUCTION

Define externalities

Externalities are unintended costs or benefits imposed on third parties who are not directly involved in economic transaction

What type of effects are they, and on who?

Spillover effects onto third parties in society

What are the two types of externalities?

Positive (imposes unintended benefits), negative (imposes unintended burdens)

What are the two causes of externalities?

Spill over affects from production and consumption

Why are externalities inevitable?

As every human action and economic transaction has rippling, interconnected effects beyond the immediate buyer and seller

Give an example of a negative externality in production

Factory pollution

A factory dumping chemical waste into a river, harms the ecosystems as well as people

Give an example of a negative externality in consumption

Secondhand smoke

A person smoking in a public area negatively affects the health of nearby non-smokers

Give an example of a positive externality in production

Vaccines

They protect the individual and the risk of spreading in society

Give an example of mixed externalities

Tourism

Brings economic growth and jobs, but leads to congestion and environmental degradation

How do externalities cause market failure?

Market prices for to reflect the true total cost of benefits of a good or service, this misalignment between private and social costs creates an inefficient allocation resources

Is social costs or social benefits involved in production or consumption?

MSC - production

MSB - consumption

Who is the MPC paid by?

The business

Who is the MEC paid by?

Society

What is a private cost?

The direct internal expenses paid by producer or consumer for a transaction

What is an external cost?

The spell over affects imposed on uninvolved third parties (negative externalities)

What are private benefits?

Direct gains enjoyed by individuals or firms involved in an economic transaction

What are external benefits?

Benefits android by uninvolved third parties (positive externalities)

Give an example of external benefits

One person having a vaccine, this creates a healthier community overall

What is Marginal Private Cost? (MPC)

The internal cost to a producer or consumer from supplying or consuming one extra unit of a good or service

What is Marginal Private Benefit? (MPB)

The extra benefit satisfaction or utility gained by a consumer or producer through consuming or producing one extra unit of a good service

What is Marginal External Cost? (MEC)

The cost imposed on third-parties by the production or consumption of one additional unit of a good or service

Give an example of marginal external cost

Pollution/environmental damage, which the firm does not pay for

What is Marginal Social Cost? (MSC)

The total cost of society of producing or consuming one additional unit of a good or service

How do you calculate the marginal social cost?

marginal private cost + marginal external cost

What is the equation if there is no externalities?

MPC = MSC

What is the equation if there is negative externalities?

MSC > MPC

How do you calculate social cost?

social cost = private cost + external cost

How do you calculate social benefit?

social benefit = private benefit + external benefit

Give 6 examples of negative externalities from production

1. Air pollution from factories

2. Pollution from fertilizers

3. Industrial waste

4. Noise pollution

5. Space junk

6. Methane emissions

Give 8 examples of negative externalities from consumption

1. Particulates from vehicle pollution

2. Household waste

3. Noise pollution from neighbors

4. Air pollution from smokers

5. Traffic congestion

6. Impact of gaming addiction on families

7. Litter damaging beaches and motorways

8. Spillover costs from rising levels of obesity

What are some spillover effects from obesity?

Causing illness - NHS - or if people are caring for others, this means they are not in work which reduces the productivity of the economy

Why is marginal output important?

It considers the impact of one more unit of consumption or production

What is the private optimum level of output?

Occurs when marginal private benefit = marginal private cost

MPB = MPC

Diagrams from whole booklet

IN BOOKLET

What is the social optimum level of output when there are negative externalities?

The quantity where the marginal social cost = the marginal social benefit

MSC = MSB

At this point, the total benefit society gets from producing and consuming one more unit perfectly offsets the total costs imposed on everyone

When does market failure occur?

Any time the free market fails to allocate resources efficiently to maximize overall social welfare

Do negative externalities lead to market failure?

Yes

How can we analyze negative externalities using cost and benefit curve diagrams?

What are positive externalities?

They exist when third parties benefit from the spillover effects of production or consumption

At this point, social benefits, exceed private benefits

How do you calculate social benefit?

social benefit = private benefit + external benefit

How do you calculate marginal social benefit?

marginal private benefit + marginal external benefit

MSB = MPB + MEB

Give 8 examples of positive externalities from consumption

1. Health care services

2. Wearing a face mask during a public health crisis

3. Subsided cycle schemes in urban areas

4. Public libraries/community spaces including parks

5. Museums and galleries open access to the general public

6. Free school meals/improved nutritional advice

7. Apple orchards that allow bee populations to grow

8. People taking up the offer of vaccinations

How can we analyze positive externalities using cost and benefit curve diagrams?

Because a positive externality exists, the MSB curve lies above the MPB curve (the vertical distance between them, represents the value of the external benefit)

Give an example of a negative production externality?

Pollution (noise, light, air)

Give an example of a real place that has lots of pollution? Why do they?

Manchester Airport (they act in their own self interest)

Where is the welfare loss shown on a diagram?

The area between the MSB and MSC curves

What interventions might be used to address the market failures from positive externalities?

Subsidies, direct government provision, legislation and regulation, information campaigns, taxation

What are positive externalities from production?

Research and development, employee training, infrastructure development, software available to other users

How do we show the social welfare loss arising from this underproduction?

The area where the price consumers are willing to pay, exceeds the cost to produce, but production has stopped short of that point (shading this triangle, illustrates the total welfare foregone by the economy)

Define mixed externalities

Occurs when a single economic activity generates both external costs and external benefits (spill over effects) for third-party who are not directly involved in the transaction

Give examples of mixed externalities

Plastic production, wind turbines, new housing construction

What is a carbon tax?

A tax on the consumption or production of goods and services which cause carbon emissions

What do we mean by regulatory intervention to reduce externalities?

Refers to the use of government power, laws, rules or restrictions to influence the behave of firms or individuals when their actions impose costs (or benefits) on third parties

6 examples of regulatory interventions with externalities

1. Smoking bans in public places

2. Minimum age laws for tanning salons/gambling

3. Maximum CO2 emissions for new vehicles

4. Recycling for household appliances

5. Banning wet wood for indoor wood burners

6. Fishing quotas to protect stocks from over fishing

Give 3 negative externalities caused by excess chemicals leaked into rivers from farming

1. Health (drinking polluted water - increased burden on the NHS)

2. Nature (loss of biodiversity)

3. Economic impact (wider cost to tourist businesses, house prices in areas affected)

What is allocative efficiency?

An economic state where resources are distributed to perfectly much consumer preferences

Society produces exactly what people want and are willing to pay for

Allocative efficiency equation?

P = MC

Is there externalities in a perfectly competitive market where there is allocative efficiency?

No (neither positive or negative)