Negative externalities

• What are externalities?

  • Externalities occur when there is an external impact on a third party not involved in the economic transaction
  • These impacts can be negative or positive and are often referred to as spillover effects
  • These impacts can be on the production side of the market (producer supply) or on the consumption side of the market (consumer demand)
• What are external costs?

  External costs occur when the social costs of an economic transaction are greater than the private costs.

  • An external cost (negative externality) is the damage not factored in to the economic activity (for example, generating air pollution when producing electricity)
• What are private costs?

  • A private cost for the producer is what they actually pay to produce a good/service
• What are social costs?

  Private costs + external costs
• What are external benefits?

  External benefits occur when the social benefits of an economic transaction are greater than the private benefits

  • An external benefit (positive externality) is the benefit not factored in to the economic activity (for example, someone who studies law enjoys private benefits but society benefits from having strong legal institutions)
• What are private benefits?

  • A private benefit for the consumer is what they actually gain from consuming a good/service
• What are social benefits?

  External benefits+ private benefits
• What are negative externalities of production?

  • Negative externalities of production are often created during the production of a good/service
  • The externalities are caused by producer supply and result in a negative external impact on a third party
  • As only the private costs are considered by producers and not the external costs, firms will over-produce these goods and services, causing market failure
  • If the external costs were considered, the quantity of goods and services produced would decrease, and they would be sold at a higher price
• What are negative externalities of consumption?

  Negative externalities of consumption are often created during the consumption of a good/service

  • The externalities are caused by consumer demand and result in a negative external impact on a third party
  • As only the private costs are considered by consumers and not the external costs, individuals will over-consume these goods and services, causing a market failure
  • If the external costs were considered, the quantity of goods and services demanded would decrease, and they would be sold at a lower price