Quick run through of externalities diagrams

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Quick run through of externalities diagrams

  1. 1. Quick Run Through ofExternalities DiagramsAS Micro EconomicsUnit 1
  2. 2. What are externalities?• Externalities are third party ‘spill-over’ effects arisingfrom production and consumption of goods andservices for which no appropriate compensation is paid• They can cause market failure if the price mechanismdoes not take into account the full social costs andbenefits of production and consumption• Externalities occur outside of the market i.e. theyaffect economic agents not directly involved in theproduction and/or consumption of a good or service
  3. 3. Private and Social Costs• Private Costs– Are paid only by the producer or consumer concerned– They are internal costs of production or consumption• Social Costs– Social Cost = Private Cost + External Cost– Negative externalities add to social costs or reduce socialbenefits– We assume that the consumer and/or producer does not takeexternal costs into account when making decisions– This can lead to a misallocation of resources (causing a loss ofallocative efficiency)– This means that social welfare is not maximized - a cause ofmarket failure
  4. 4. QuantityCostsBenefitsNEGATIVE EXTERNALITIESMarginalprivate cost
  5. 5. QuantityCostsBenefitsNEGATIVE EXTERNALITIESMarginalprivate costMarginalsocial cost
  6. 6. QuantityCostsBenefitsNEGATIVE EXTERNALITIESMarginalprivate costMarginalsocial costExternal cost
  7. 7. QuantityCostsBenefitsNEGATIVE EXTERNALITIESMarginalprivate costMarginalsocial costMarginal private benefit= marginal social benefit
  8. 8. QuantityCostsBenefitsNEGATIVE EXTERNALITIESMarginalprivate costMarginalsocial costMarginal private benefit= marginal social benefitQ1External cost
  9. 9. QuantityCostsBenefitsNEGATIVE EXTERNALITIESMarginalprivate costMarginalsocial costMarginal private benefit= marginal social benefitQ1Q2AExternal costAPrivateoptimum
  10. 10. QuantityCostsBenefitsNEGATIVE EXTERNALITIESQ1Q2BAAPrivateoptimumBSocialoptimumMarginalsocial costMarginalprivate costMarginal private benefit= marginal social benefit
  11. 11. QuantityCostsBenefitsNEGATIVE EXTERNALITIESMPCMSCMPB = MSBQ1Q2APrivateoptimumBSocialoptimumSocial welfareloss
  12. 12. Positive Externalities• Private benefits– The utility derived from consumption (for aconsumer)– The revenue accruing to a producer• Social benefit– Social benefit = Private benefit + External benefit• With positive externalities, social benefit >private benefit
  13. 13. QuantityCostsBenefitsPOSITIVE EXTERNALITIESMarginal PrivateBenefitMarginal SocialBenefit
  14. 14. QuantityCostsBenefitsPOSITIVE EXTERNALITIESMarginal PrivateBenefitMarginal SocialBenefitExternal Benefit
  15. 15. QuantityCostsBenefitsPOSITIVE EXTERNALITIESMarginal PrivateBenefitMarginal SocialBenefitMarginal PrivateCost
  16. 16. QuantityCostsBenefitsPOSITIVE EXTERNALITIESMarginal PrivateBenefitMarginal SocialBenefitMarginal PrivateCostAPrivateoptimumA
  17. 17. QuantityCostsBenefitsPOSITIVE EXTERNALITIESMarginal PrivateBenefitMarginal SocialBenefitMarginal PrivateCostAPrivateoptimumABSocialoptimumB
  18. 18. QuantityCostsBenefitsPOSITIVE EXTERNALITIESMarginal PrivateBenefitMarginal SocialBenefitMarginal PrivateCostAPrivateoptimumABSocialoptimumBWelfare lossfrom under-consumption

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