module 7.5 - externalities

positive externality

occurs when the production or consumption of a good or service benefits a third party who is not directly involved in the transaction (and who does not pay for it)

• “spillover effect”

• education, vaccinations, research and development, etc

negative externality

occurs when the production or consumption of a good or service imposes a cost on the third party not involved in the transaction

• air pollution

• water pollution

• noise pollution

• second-hand smoke

social costs

refers to the total cost to society resulting from an economic activity

• private cost (raw materials, labor wages, etc) + external cost (pollution, traffic, noise, climate change)

social benefits

represents the total benefit to society from the production or consumption of a good or service

• private benefit (high income, better job prospects) + external benefit (education, vaccinations, etc)

market failure

occurs when the free market, operating on its own, fails to allocate resources efficiently

• resources not distributed in a way that maximizes overall societal wellbeing

optimal quantity

the level of production or consumption of a good or service that maximizes some specific objective, depending on context