1.3.3 Negative externalities

What is a negative externality

When the consumption or production of good has a negative cost to a third party. They are typically over produced by the market mechanism

Draw a diagram for a negative externality

Using the diagram define the term marginal external cost

The difference between the MSC and the MPC is the marginal external cost and it is the cost to the third party caused by the private transaction.

Using the diagram define the term overproduction

The free market equilibrium is where MPC=MPB

The socially optimum equilibrium is where MSC=MSB

The gap between the two is overproduction

Using the diagram define the term welfare loss

Welfare loss is represented by the by the area where the cost to society is greater to the benefit to society. Reducing output to closer towards Qso starts to eliminate welfare loss.