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

  

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