neg externalities - market failure

• Negative externalities

  Costs of third parties as a result of the actions of a separate agent
• Types of negative externalities


  • Negative externalities in production
  • Negative externalities in consumption
• Negative externalities in production

  Costs of third parties as a result of the actions of producers
• Negative externalities in production


  Marginal social cost is greater than marginal private cost
• Showing negative externalities in production on a diagram

  1. Marginal private cost

  2. Marginal social cost is greater than marginal private cost

  3. Market allocates resources at private optimum

  4. Social optimum where marginal social cost equals marginal social benefit

  5. Welfare loss is the triangle pointing towards social optimum
• Negative externalities in consumption


  Costs of third parties as a result of the actions of consumers
• Negative externalities in consumption


  • Smoking affecting bystanders
  • Excessive alcohol consumption affecting health services and police
  • Excessive sugary drink/fast food consumption affecting health services
• Negative externalities in consumption


  Marginal social benefit is less than marginal private benefit
• Showing negative externalities in consumption on a diagram

  1. Marginal private benefit

  2. Marginal social benefit is less than marginal private benefit

  3. Market allocates resources at private optimum

  4. Social optimum where marginal social benefit equals marginal social cost

  5. Welfare loss is the triangle pointing towards social optimum
• Consumers and producers are ignoring the full social costs/benefits of their actions due to self-interest
• The market allocates resources at the private optimum instead of the social optimum, leading to misallocation of resources and a welfare loss