4 Positive and negative externalities

when do externalities exist

when there is a divergence between private and social costs/benefits

What is an externality

An indirect cost or benefit incurred by a third party that is not accounted for in the price

MSB =

MPB + MEB

MSC =

MPC + MEC

if it is a production externality there are 2

cost curves

if it is a consumption externality then there are 2

benefit curves

if MEB is negative

negative consumption externality

if MEB is positive

positive consumption externality

If MEC is negative

positive production externality

if MEC is positive

negative production externality

the triangle of deadweight loss always

points to the socially oprtimum point of production

why are negative/positive externalities likely to result in over/under production?

only private costs are considered in economic descision making (homoeconomicus)

why the absence of property rights leads to externalities in consumption and production

An absence of boundaries allows free-riders uncontrolled access, which can result in the over-exploitation or misuse of the resource (tragedy of commons).

The moral hazard assumes someone else will pay the consequences for a poor choice. For example, some people might litter the street if they think that other people will clear up after them.

Mixed externalities

Positive and negative externalities → eg fireworks

Another name for negative externalities

Spillover effects

Where is the social optimum

Where MSB = MSC

Where is the free market equilibrium

Where MPB = MPC