MRU - An introduction to externalities

private cost: the cost paid by the consumer or the producer

external cost: a cost paid by bystanders, by people other than the consumer or the producer

social cost: the cost to everyone, the private cost plus the external cost

externalities: external costs or external benefits

• costs or benefits that fall on bystanders

social surplus = consumer surplus + producer surplus + bystander's surplus

• when there are significant externalities, the market will not maximize social surplus

when there are external costs, output should be reduced to maximize social surplus

for determining the efficient level of output, who bears the cost is irrelevant

when other people bear some of the costs, the price is too low and antibiotic users purchase too many antibiotics

one of the solutions is

• Pigouvian tax: a tax on a good with external costs