Externalities Diagrams

• What does P/C stand for in economic diagrams?

  Price/Cost
• What does S=PMC represent?

  Supply equals Private Marginal Cost
• What does D=SMB=PMB indicate?

  Demand equals Social Marginal Benefit equals Private Marginal Benefit
• What do P1 and P2 represent?

  Prices at different equilibrium points
• What do Q1 and Q2 represent?

  Quantities at different equilibrium points
• What is the difference between Free Market Allocation and Socially Optimal Allocation?

  • Free Market Allocation: PMB = PMC
  • Socially Optimal Allocation: SMB = SMC
• What is meant by External Cost?

  Costs not reflected in market prices
• What does it mean if a good is Underpriced?

  Price is lower than its true cost
• What does Net Welfare Loss refer to?

  Loss of economic efficiency in allocation
• What does it mean if a good is Overproduced?

  More is produced than socially optimal
• What is the explanation for Negative Production Externalities?

  Social Marginal Costs > Private Marginal Costs
• What are the key components of the diagram for Negative Production Externalities?

  • Axes: Price/Costs/Benefits (Y-Axis), Quantity (X-Axis)
  • Curves: SMC > PMC and SMB = PMB
  • Equilibrium Points: PMB = PMC (Free Market), SMB = SMC (Socially Optimal)
• What does the vertical distance in the diagram represent for Negative Production Externalities?

  External Cost
• What does shading in the diagram indicate?

  Net Welfare Loss
• What does it mean if a good is Underpriced in the context of Negative Production Externalities?

  P1 < P2
• What does it mean if a good is Overproduced in the context of Negative Production Externalities?

  Q2 < Q1
• What are the key components of the diagram for Positive Production Externalities?

  • Axes: Price/Costs/Benefits (Y-Axis), Quantity (X-Axis)
  • Curves: SMC < PMC and SMB = PMB
  • Equilibrium Points: PMB = PMC (Free Market), SMB = SMC (Socially Optimal)
• What does it mean if a good is Overpriced in the context of Positive Production Externalities?

  P1 > P2
• What does it mean if a good is Underproduced in the context of Positive Production Externalities?

  Q2 > Q1
• What does it mean if Social Marginal Costs are less than Private Marginal Costs?

  Indicates Positive Production Externalities
• What are the key components of the diagram for Negative Consumption Externalities?

  • Axes: Price/Costs/Benefits (Y-Axis), Quantity (X-Axis)
  • Curves: SMB < PMB and SMB = PMB
  • Equilibrium Points: PMB = PMC (Free Market), SMB = SMC (Socially Optimal)
• What does it mean if a good is Overconsumed in the context of Negative Consumption Externalities?

  Q2 < Q1
• What does it mean if a good is Overvalued in the context of Negative Consumption Externalities?

  P1 > P2
• What are the key components of the diagram for Positive Consumption Externalities?

  • Axes: Price/Costs/Benefits (Y-Axis), Quantity (X-Axis)
  • Curves: SMB > PMB and SMB = PMB
  • Equilibrium Points: PMB = PMC (Free Market), SMB = SMC (Socially Optimal)
• What does it mean if a good is Underconsumed in the context of Positive Consumption Externalities?

  Q2 > Q1
• What does it mean if a good is Undervalued in the context of Positive Consumption Externalities?

  P2 > P1
• What does it mean if Social Marginal Benefits are less than Private Marginal Benefits?

  Indicates Negative Consumption Externalities
• What does it mean if Social Marginal Benefits are greater than Private Marginal Benefits?

  Indicates Positive Consumption Externalities
• What does the vertical distance in the diagram represent for Positive Consumption Externalities?

  External Benefit
• What does shading in the diagram indicate for Positive Consumption Externalities?

  Net Welfare Loss