1.3.2 Externalities

    0
    38

    a) Distinction between private costs, external costs and social costs
    Negative externality – social costs of an economic action are greater than the private costs
    Private costs are costs that occurs to the individual economic agent
    External costs are costs that accrue to the third parties that are outside of the decision to consume or produce that good or service
    Social costs are the costs to society as a whole and therefore include both the private and external cost

    What is the equation for social costs?
    Negative Social Costs = Marginal Private Costs + External Costs
    What happens if external costs exist?
    Marginal social cost will be greater than marginal private cost
    What happens if the external cost does not exist?
    Marginal social cost will be equal to marginal private cost
    Negative externalities exist when MSC > MPC

    b) Distinction between private benefits, external benefits and social benefits
    Positive externality – social benefits of an economic action are greater than the private benefits
    Private benefits are the benefits that occurs to the individual economic agent
    External benefits are benefits that accrue to the third parties that are outside of the decision to consume or produce that good or service
    Social benefits are the benefits to society as a whole and include both the private and external benefits
    Private and External benefit of healthcare and education

    What is the equation for social benefits?
    Positive Social Benefits = Marginal Private Benefits + External Benefits
    What happens if external benefits exist?
    Marginal social benefits will be greater than marginal private benefits
    What happens if the external benefits do not exist?
    Marginal social benefits will be equal to marginal private benefits
    Positive externalities therefore exist when MSC > MPC

    c) Use of a diagram to illustrate:
    The external costs of production using marginal analysis, The distinction between market equilibrium and social optimum position and Identification of welfare loss area

    As an external cost exists, the marginal social cost is greater than the marginal private cost
    The economic agent under existence of a negative externality only takes into account the marginal private costs and so the good is over produced and over consumed at Q1 at a lower price than P1
    Known as the free market or inefficient outputs (try and label)
    If the economic agent took into account the external costs, then it would produce and consume at a lower output Qe and a higher price Pe
    Known as the socially optimum or efficient output (label)
    Welfare loss – overall loss to society of the consumption or production of a good or service
    For every unit produced or consumed from Qe to Q1, cost to society (MSC) is greater than the marginal social benefit (MSB). Society essentially loses out. d) Use of a diagram to illustrate:
    The external benefits of consumption using marginal analysis, The distinction between market equilibrium and social optimum position and Identification of welfare gain area

    Why do the two curves diverge from each other?
    MSB is made up of external benefits and MPB so, MPB is separate from MSB
    Where is inefficient (free market) output? Why?
    Not the maximum to society, only the MPB. Underemployment and under produced
    Where is efficient (socially optimum) output? Why?
    Where private and external benefits can be taken into consideration
    Why is there welfare gain?
    Area for where every unit has a greater benefit to society than to private benefits

    Solution to correct market failure:
    Taxing fast food to make it more expensive
    Trying to make fast food healthier
    Making expensive food more affordable
    Advertisements to deter consumers from purchasing fast food products
    Correct externality diagram:

    Solution to correct market failure:
    Higher taxes on fuels
    Parking meters to deter car usage
    Promoting electric vehicles
    Correct externality diagram:

     

     

     

    LEAVE A REPLY

    Please enter your comment!
    Please enter your name here