Externalities

• Private Cost/benefit

  cost/benefit of doing something for either a consumer or a firm
• social cost/benefit

  total cost/benefit of both private and external cost/benefit
• external cost/benefit

  cost/benefit for those not involved in an transaction
• why are externalities a market failure?

  price no longer reflects external costs
• Negative externalities in production

  • SOE to the left of FME
  • demand curve
• positive externalities in production

  • SOE to right of FME
  • demand curve
• negative externalities in consumption

  • SOE to left of FME
  • supply curve
• positive externalities in consumption

  • SOE to right of FME
  • supply curve
• merit good

  a good that has positive externalities after the point of consumption, e.g. education
• demerit good

  a good that has negative externalities after the point of consumption, e.g. cigarettes and alcohol