2). Externalities

• What is an externality?

  An externality is a cost or benefit that is external to a market transaction (i.e. affects a third party) and is therefore not reflected in the market price. 'Externalities' is just a term that refers to both external costs and external benefits.
• Social Costs = Private Costs + External Costs
• Social Benefits = Private Benefits + External Benefits
• Different types of costs:

  • Private costs are incurred by the consumers/producers who are directly involved in the consumption/production process.
  • External costs are costs experienced by a third party (a consumer or producer) that is not directly involved in the consumption or the production of the good or service.
  • Marginal Social Cost is the cost to society of producing or consuming an extra unit of good.
• Different types of benefits:

  • Private benefits are benefits incurred by the consumers /producers who are directly involved in the consumption/production process.
  • External benefits are benefits experienced by a third-party that is not directly involved in the consumption or the production of the good or service.
  • Marginal Social Benefit is the benefit to society of producing or consuming an extra unit of a good.
• When do externalities happen?

  Externalities happen when there is a difference between marginal social cost and marginal social benefit. Externalities arise in both consumption and production.
• Negative Externality Diagram:

  *Write on this later

  
• Positive Externality Diagram:

  *Write on this later