1.3.2 Externalities

• An externality is the cost or benefit a third party receives from an economic transaction outside of the market mechanism.
• Private costs are the costs to economic agents directly involved in an economic transaction.
• Social costs are the cost to the whole society.
• Social Cost = Private Costs + External Costs
• External costs are the difference between private costs and social costs.
• The social optimum position is where the marginal social costs are equal to the marginal social benefit and is the point of maximum welfare.
• external costs occur when a good is being produced or consumed, shown by the vertical distance between MSC and MPC.
• The output where social costs are greater than private costs is known as the area of deadweight welfare loss.

  
• Government Policies for Negative Externalities

  1. Indirect Taxes
  2. Subsidies
  3. Regulation
  4. Directly Providing the Good
  5. Provide Information
  6. Property Rights
  7. Personal Carbon Allowances
• Characteristics of a Private Good

  1. Rival
  2. Excludable