Externalities

• Market failure

  When allocative efficiency is not achieved, resulting in under or overallocation of resources (not socially optimal)
• Allocative efficiency


  Achieved when D=S or when MB=MC
• Demand

  Marginal benefit
• Marginal benefit

  The additional benefit of consuming one more unit of the good
• The more you consume of a good, the less happiness each additional object brings
• Supply

  Marginal cost
• Marginal cost

  The additional costs of producers pay to produce one more unit of the good
• Marginal private cost (MPC)

  Cost to producers of producing one more unit of good
• Marginal social cost (MSC)


  Cost to society of producing one more unit of good
• Marginal external cost (MEC)

  The additional cost imposed on third parties by the consumption of an extra unit of a good or service
• Marginal external benefit (MEB)

  The additional benefit imposed on third parties by the consumption of an extra unit of a good or service
• Marginal private benefit (MPB)


  Benefits to consumers from consuming one more unit of a good
• Marginal social benefit (MSB)

  Benefits to society from consuming one more unit of a good
• When MPC = MSC and MPB=MSB, socially optimal equilibrium is achieved
• If there is a different between social and private, not good
• Externalities

  Occur when the production or consumption of a good/service cause external costs and/or external benefit
• Externalities

  • They are the side effects of economic activity or unintended consequences of economic activity
  • The side effects impact a third party
• Externalities

  Cause market failure if the price mechanism (i.e. Price) does not take into account the social costs and benefits of production and consumption
• Market failure

  When the external benefits/cost are not recognised, leading to miss allocation
• Negative externalities

  Occurs when production and/or consumption creates an external cost (to society)
• Negative externalities

  • Causes overconsumption/production
  • Market quantity is greater than optimal quantity, but we should be producing less because it is harmful to society
  • Market price is less than optimal price
• Negative externalities result in deadweight loss
• Positive externalities

  External benefits of consumption or production for third parties
• Positive externalities


  • Benefits are not recognised, hence there is too little of the good being produced or consumed, therefore there is DWL
  • Causes under consumption or production
• Positive externalities result in deadweight loss