negative externalities

• Negative externalities


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

  • Production
  • Consumption
• Negative externalities in production


  • Costs of third parties as a result of the actions of producers
  • Examples: air pollution, resource depletion, resource degradation, deforestation
• Showing negative externalities in production on a diagram


  1. Marginal social cost is greater than marginal private cost

  2. Social cost = private cost + external cost

  3. Leads to overproduction and overconsumption

  4. Welfare loss is the triangle pointing towards the 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
• Showing negative externalities in consumption on a diagram


  1. Marginal social benefit is less than marginal private benefit

  2. Leads to overconsumption and overproduction

  3. Welfare loss is the triangle pointing towards the social optimum
• Consumers and producers are ignoring the full social cost/benefit 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 inefficiency
• The result is overproduction, overconsumption, and a welfare loss to society