Externalities

Antibiotic users get all of the benefits from the the antibiotics, but they don’t bear all of the costs
The person who needs an antibiotic must pay a private cost for the antibiotic, the market price
- Private cost: a cost paid by the consumer or the producer
Because each of the antibiotics pollutes the environment with more resistant and stronger bacteria, each of the antibiotics creates an external cost
- External cost: a cost paid by a bystander other than a producer or consumer
Social cost: the cost to everyone (private cost + external cost)
Since external cost isn’t paid by consumers or producers, it’s not built into the price of antibiotics
- When patients or farmers choose whether to use more antibiotics, they compare their private benefits with the market price, but they ignore the external costs
- This makes antibiotics overused
Since the price of antibiotics doesn’t include all of the costs of using antibiotics, the price sends an imperfect signal
- The price is too low so antibiotics are overused

Externalities: external costs or benefits
- Costs or benefits of something that fall on the bystander
External costs are also called negative externalities and external benefits are called positive externalities
When externalities are significant, markets work less well and government action can increase social surplus
Market equilibrium maximizes consumer plus producer surplus (gains from trade)
- Maximizing consumer + producer surplus isn’t good if bystanders are harmed in the process
If we want to see how well a market with externalities is working, look at the social surplus (consumer surplus + producer surplus + everyone else’s surplus)
You can read the value of the nth unit of a good from the height of the demand curve and the cost of the nth unit of a good from the height of the supply curve
- Ex: imagine that buyers and sellers are currently exchanging 99 units of a good
- What is the value to buyers and the cost to sellers of one additional unit, the 100th unit?