Positive & Negative Externalities 2022.pptx

http://www.bized.co.uk
Copyright 2006 – Biz/ed
Positive and Negative
Externalities

Positive and Negative
Externalities
• An externality is the
uncompensated impact of one
person’s actions on the well-being
of a third-party (bystander)
• Adverse impact Negative externality
• Beneficial impact Positive externality
• Buyers and sellers neglect external effects of
their actions therefore the market equilibrium
is not efficient when there are externalities

• Externalities cause markets to be
inefficient, and thus fail to
maximize total surplus.

Private & Social Cost
• Private cost: the cost producing
the good paid by the firm
• Social cost: the cost to everyone in
society, including people who do
not produce or consume.
• Social cost = private cost +
external cost

Private & Social Benefit
• Private benefit: benefit to the person
who buys and consumes the good
• Social benefit: the total benefit to all
of society
• An externality occurs when private
costs > or < social cost
• Or when Private Benefit is > or <
social benefit

• Costs and benefits in production:
• External costs in production: where MSC =
MSB – MPC
– e.g. air and water pollution, congestion, housing
development on green belt areas, destruction of
hedgerows and wildlife, noise, pollution, anti-social
behaviour, crime
• External benefits in production – where MSC <
MPC
– e.g. human resource development, research and
development in industry
Positive and Negative Externalities

EXTERNALITIES AND MARKET INEFFICIENCY
• Negative Externalities
• Automobile exhaust
• Cigarette smoking
• Barking dogs (loud pets)
• Loud stereos in an apartment building

EXTERNALITIES AND MARKET INEFFICIENCY
• Positive Externalities
• Immunizations
• Restored historic buildings
• Research into new technologies

Private and social costs
Private costs
Financial
Health
External costs
External benefits
Private benefits
A divergence between
private and social costs
and benefits?

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
social benefits
• We assume that the consumer and/or producer does
not take external costs into account when making
decisions
• This can lead to a misallocation of resources
(causing a loss of allocative efficiency)
• This means that social welfare is not maximized - a
cause of market failure

Social cost
Private Costs + External cost = Social Costs
Cost to
individual
consumers or
firms of their
economic
activity
Cost to others of
individual
consumers or
firms economic
activity
Total cost to
society of a
given
economic
activity
Cost to first
parties -
individuals
Cost to third
parties - others
Total Cost to
society -
everyone

Negative Externalities & Market Failure
Private Optimum – where MPC = MPB
Costs
Benefits
Output (Q)
PMB = SMB
PMC
Qp
Assuming no negative
externalities from
consumption

Add in the External Cost
Costs
Benefits
Output (Q)
Private benefit =
social benefit
Private
Cost
Social
Cost
Qp

Add in the External Cost
Costs
Benefits
Output (Q)
PB = SB
PC
SC
Qp
External Cost

The Social Optimum Output
Costs
Benefits
Output (Q)
PB = SB
PC
SC
Qp
External Cost
Qs

Explaining the market failure
• The efficient allocation of resources
requires output to be increased up to the
point where social benefit equals social
cost.
• In a free market firms only take into
account the private costs of their
production.
• Given negative externalities - such as
pollution - private and social costs
diverge.
• An unregulated (free) market
consequentially overproduces the good.

Positive externalities from education
and training
 Improved social skills and awareness of citizenship
 Greater long-term contribution to the economy
 Higher productivity
 Diffusion of knowledge and understanding
 Improved employability / reduced risk of structural
unemployment
 Impact on international competitiveness from an
improvement in human capital
 All of the above should help to contribute to a higher
trend rate of growth
 Higher expected earnings might provide increased
tax revenues for the government

Private benefits & Social benefits
• Private benefit
• The utility derived from consumption (for a
consumer) The revenue accruing to a producer
• Social benefit
• Where there are positive externalities the social
benefit of production and/or consumption
exceeds the private benefit

Social benefits explained
+ External benefits =
Benefits to others of
individual
consumers or firms
economic activity
Social
Benefits
Total benefits to
society of a
given economic
activity
Private
Benefits
Benefits to
individual
consumers or
firms of their
economic
activity
Benefits to
first parties -
individuals
Benefits to third
parties - others
Total benefits
to society –
everyone

Positive spill-overs
Flood protection schemes,
immunization and galleries and
museums all provide external
benefits
Left to itself, would the free-
market fail to provide sufficient
products that yield positive
externalities?

Positive externalities and market failure
Output
Costs
and
Benefit
s
Margin
al
Private
Benefit
Marginal
Private Cost =
Marginal
Social Cost
Margin
al
Social
Benefit
Q2
Q1
Consumer
Surplus
Produce
r Surplus
Equilibriu
m output

Output
Costs and
Benefits
Marginal Private
Benefit
Marginal Private Cost =
Marginal Social Cost
Q2
Q1
Consumer
Surplus
Producer
Surplus
Equilibrium
output
Gain to
other
people
Marginal Social Benefit

Output
Costs
and
Benefits
Marginal Private
Benefit
Q2
Q1
In a free market
consumption will be at Q1
because Demand = Supply
(private benefit = private
cost )

Positive externalities and
market failure
Costs
and
Benefits
Marginal Private Benefit
Q1 Q2 Output
However this is socially
inefficient because Social
Cost < Social Benefit.
Therefore there is under
consumption of the
positive externality

Output
Costs
and
Benefits
Marginal Private Benefit
Q2
Q1
Social Efficiency would
occur at Q2 where Social
Marginal Cost = Social
Marginal Benefit

Output
Costs
and
Benefits
Marginal Private
Benefit
Q2
Q1
Welfare loss from
the good being
under-consumed
Under-consumption of
products with positive
externalities leads to a net
loss of social welfare –
shown in the diagram above

• Costs and benefits in consumption:
• External costs in consumption –
where MSB < MPB
– e.g. passive smoking, litter, noise,
anti-social behaviour
• External benefits in consumption –
where MSB > MPB
– e.g. preventative health care –
vaccinations, public transport, attractive
gardens, bathing regularly!

• External costs – socially efficient
output is less than current output
• External benefits – socially
efficient output is greater than
current output
• Socially efficient output is where
MSC + MPC = MSB + MPB

• Weighing up the costs and benefits
• Benefits from production of
chemicals/pharmaceuticals and energy
• Costs of generating these products/services
Copyright: Karoly Feher and Drew Broadley, stock.xchng

Positive & Negative Externalities 2022.pptx

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