negative externalities

• Market failure occurs when the free market fails to allocate resources at the socially optimal level.
• Negative externalities are detrimental third-party effects resulting from economic transactions.
• Negative externalities harm someone not involved in the transaction.
• Why do negative externalities cause market failure?

  Misallocation of resources
• When illustrating negative externalities in consumption, the social benefit curve shifts to the left.
• The private benefit curve is unaffected when illustrating negative externalities in consumption.
• Steps to illustrate negative externalities in consumption on a diagram

  1️⃣ Draw downward-sloping private benefit curve

  2️⃣ Draw upward-sloping private cost curve

  3️⃣ Shift the social benefit curve to the left

  4️⃣ Identify private equilibrium

  5️⃣ Identify social optimum

  6️⃣ Calculate welfare loss
• The welfare loss from negative externalities is represented by a triangle pointing towards the social optimum.
• What does the market equilibrium consider in the presence of negative externalities?

  Private costs and benefits
• The social benefit curve accounts for the external costs of negative externalities.
• What is an example of a negative externality in consumption?

  Passive smoking
• Negative externalities in consumption lead to overproduction because private consumers only consider their self-interest.
• In negative externalities in production, the social cost curve shifts to the left.
• The private cost curve remains unchanged when illustrating negative externalities in production.
• What is an example of a negative externality in production?

  Pollution
• Firms tend to ignore the external costs of negative externalities because they focus on their private costs.
• Negative externalities in production result in overproduction compared to the socially optimal level.