Pos + Neg Externalities in consumption and production

• What are externalities?

  The cost or benefit a 3rd party receives as a result of an economic transaction that they are not involved in as a result of the market mechanism. They can be both positive and negative.
• What are private costs?

  The costs faced by the producer (costs of production) or consumer (market price for a good) directly involved in a transaction.
• What are social costs?

  private cost + external cost. The total cost to society.
• What are private benefits?

  Benefits for producer or consumer directly involved in an economic transaction
• What are social benefits?

  External Benefits + Private Benefits. The total benefit on society.
• When can allocative efficiency occur?

  When there is a maximisation of society surplus (when MSC=MSB at Pand Q).
• What are the effects of negative externalities on production?

  MSC>MPC. Firms are ignoring social costs due to their own self-interest. Therefore, the market is operating at the private optimum rather than the social optimum (allocative efficiency). This causes there to be an overproduction and thus an overconsumption of goods and services (misallocation of resources). The price is too low as firms are only accounting for private costs which leads to market failure.

  
• What are the effects of negative externalities of consumption?

  MPB>MSB. Consumers are ignoring social benefits due to their own self-interests. This causes the market to operate at its private optimum rather than its social optimum. This leads to an overconsumption of goods and services and thus an overproduction. This causes allocative inefficiency (market failure)

  
• What are the effects of positive externalities of consumption?

  MSB>MPB. At MPB, consumers are ignoring the full social benefits due to their own self-interests. This causes the market to operate at its private optimum rather than its social optimum. This leads to an underconsumption of goods and services and thus an underproduction. This causes allocative inefficiency (market failure).

  
• What are the effects of positive externalities of production?

  MSC<MPC. At MPC, Firms are ignoring social costs due to their own self-interest. Therefore, the market is operating at the private optimum rather than the social optimum (allocative efficiency). This causes there to be an underproduction and thus an underconsumption of goods and services (misallocation of resources). The price is too high as firms are only accounting for private costs which leads to market failure.

  
• when do externalities exist?

  when there is a divergence between private and social benefit