2. What is an externality?
An externality is the external effects associated
with the production and consumption of goods
and services.
This can be further classified as positive or
negative.
3. Positive externalities
A positive externality is the benefit that is
enjoyed by a third party as a result of an
economic transaction. (Economics online)
Third parties can include any
individual, company, property owner or resource
that is indirectly effected.
4. Positive externalities diagram
This diagram highlights what
happens in order for a positive
externality to arise.
P1, Q1 represent the private benefit.
(demand is equal to supply)
This would be the benefits received
by the individual or organisation
providing the product or service.
However as a positive externality
relates to the benefits society
receives, Q2 is where the social cost
is equal to the social benefit.
D=PMB (this stands for the demand, the private benefit)
SMB (stands for the social benefit)
S=PMC=SMC (stands for supply is equal to the private cost which is equal to the social cost)
5. Example 1: Small pox vaccination
Before 1958 many people faced the threat of contracting small pox.
Small pox is a highly infectious and often lethal disease. Some of the symptoms
include:
• High fever
• Aches and pains
• The eruption of pimples that later blister and cause what is known as
pockmarks.
Because of the lack of vaccinations this meant that almost anyone was at risk
of contracting the disease and so the potential for the disease to become
widespread was great.
If the disease was to become widespread then this would cause many fatalities
and as a result the population would be significantly effected.
6. Small pox: what happened?
In order to stop the disease becoming widespread, a vaccination was
introduced and sponsored by the world health organization (WHO).
The WHO are a large organisation who are concerned with the
protection and well being of the global population. Therefore their
interest in this case was to ensure that the disease was controlled and
not passed on. The main aim was to control the disease through the
vaccination programme.
The vaccination programme was successful as in 1977 small pox
disappeared entirely and now no one will die of this disease again.
7. Why is the smallpox vaccination a
positive externality?
A positive externality is defined as the benefit enjoyed by a third party as a
result of an economic transaction.
In this case the economic transaction was the vaccination programme that
was introduced. The aim of the vaccination was to control the spread of the
disease.
The benefit that was, and still is enjoyed by the economy as a whole is that
the disease has been eradicated and now has disappeared entirely.
Now no one will ever die of this disease again as there is a vaccination to help
stop individuals contracting any further symptoms.
8. Negative externalities
Externalities are third party effects arising from
production and consumption of goods and
services for which no appropriate compensation
is paid. (Economics online)
9. Negative externality diagram
Welfare loss
This diagram highlights what
happens in order for a negative
externality to arise.
P1, Q1 represent the private
marginal benefit. (demand is equal
to supply)
SMC (stands for Social Marginal Cost)
S = PMC (stands for Supply = Private Marginal Cost)
D = PMB (stands for Demand = Marginal Private Benefit)
10. Example: Smoking
Smoking is the cause of death of 1 in 5 people in the US.
Smoking also includes passive smoking which not only affects the
smoker but also the people surrounding them.
A single cigarette contains over 4,800 chemicals which 69 of these are
known to cause cancer.
Smoking increases your risk of getting lung diseases like
pneumonia, emphysema and chronic bronchitis.
11. Smoking: What is taking place?
In 2007 legal restrictions on smoking in workplaces and public places were
introduced across England, Wales and Northern Ireland.
Regulations relating to smoking in company vehicles came into force on 1 July
2007.
Smoking is not allowed in any enclosed workplace, public building or on
public transport in the UK the penalty can be up to £200.
The legal minimum age to purchase cigarettes in the UK has risen from 16 to
18.
12. Why is smoking a negative externality?
Smoking causes damage not only to the person whom wishes to smoke but
also to the people around them who breathe in their smoke, this is a negative
externality as people whom wish to smoke are not only damaging them
selves but also forcing the people around them to smoke (also known as
passive smoking).
Smokers ignore the harmful impact of toxic ‘passive smoking’ on nonsmokers.
Since the smoking ban the emission to hospital of children with asthma has
dropped by 8% this shows that the smoking ban is decreasing the negative
externality of smoking.
