Externalities

Antibiotics

• 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

Costs, Benefits, Efficiency

• 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?

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