Positive & Negative Externalities 2022.pptx

Positive & Negative Externalities

1. Positive and Negative Externalities

2. Positive and Negative Externalities An externality is the uncompensated impact of one person’s actions on the well-being of a third-party (bystander) Adverse impact Negative externality Beneficial impact Positive externality Buyers and sellers neglect external effects of their actions therefore the market equilibrium is not efficient when there are externalities

3. Externalities cause markets to be inefficient, and thus fail to maximize total surplus.

4. Private & Social Cost Private cost: the cost producing the good paid by the firm Social cost: the cost to everyone in society, including people who do not produce or consume. Social cost = private cost + external cost

5. Private & Social Benefit Private benefit: benefit to the person who buys and consumes the good Social benefit: the total benefit to all of society An externality occurs when private costs > or < social cost Or when Private Benefit is > or < social benefit

6. Costs and benefits in production : External costs in production: where MSC = MSB – MPC e.g. air and water pollution, congestion, housing development on green belt areas, destruction of hedgerows and wildlife, noise, pollution, anti-social behaviour, crime External benefits in production – where MSC < MPC e.g. human resource development, research and development in industry Positive and Negative Externalities

7. EXTERNALITIES AND MARKET INEFFICIENCY Negative Externalities Automobile exhaust Cigarette smoking Barking dogs (loud pets) Loud stereos in an apartment building

8. EXTERNALITIES AND MARKET INEFFICIENCY Positive Externalities Immunizations Restored historic buildings Research into new technologies

9. Private and social costs Private costs Financial Health External costs External benefits Private benefits A divergence between private and social costs and benefits?

10. Private and Social Costs Private Costs Are paid only by the producer or consumer concerned They are internal costs of production or consumption Social Costs Social Cost = Private Cost + External Cost Negative externalities add to social costs or reduce social benefits We assume that the consumer and/or producer does not take external costs into account when making decisions This can lead to a misallocation of resources (causing a loss of allocative efficiency) This means that social welfare is not maximized - a cause of market failure

11. Social cost Private Costs + External cost = Social Costs Cost to individual consumers or firms of their economic activity Cost to others of individual consumers or firms economic activity Total cost to society of a given economic activity Cost to first parties - individuals Cost to third parties - others Total Cost to society - everyone

12. Negative Externalities & Market Failure Private Optimum – where MPC = MPB Costs Benefits Output (Q) PMB = SMB PMC Qp Assuming no negative externalities from consumption

13. Add in the External Cost Costs Benefits Output (Q) Private benefit = social benefit Private Cost Social Cost Qp

14. Add in the External Cost Costs Benefits Output (Q) PB = SB PC SC Qp External Cost

15. The Social Optimum Output Costs Benefits Output (Q) PB = SB PC SC Qp External Cost Qs

16. Explaining the market failure The efficient allocation of resources requires output to be increased up to the point where social benefit equals social cost. In a free market firms only take into account the private costs of their production. Given negative externalities - such as pollution - private and social costs diverge. An unregulated (free) market consequentially overproduces the good.

17. Positive externalities from education and training  Improved social skills and awareness of citizenship  Greater long-term contribution to the economy  Higher productivity  Diffusion of knowledge and understanding  Improved employability / reduced risk of structural unemployment  Impact on international competitiveness from an improvement in human capital  All of the above should help to contribute to a higher trend rate of growth  Higher expected earnings might provide increased tax revenues for the government

18. Private benefits & Social benefits Private benefit The utility derived from consumption (for a consumer) The revenue accruing to a producer Social benefit Where there are positive externalities the social benefit of production and/or consumption exceeds the private benefit

19. Social benefits explained + E x ternal b e nefi t s = Benefits to others of individual consumers or firms economic activity Social Benefits Total benefits to society of a given economic activity Private B e nefi t s Benefits to individual consumers or firms of their economic activity Benefits to first parties - individuals Benefits to third parties - others Total benefits to society – everyone

20. Positive spill-overs Flood protection schemes, immunization and galleries and museums all provide external benefits Left to itself, would the free- market fail to provide sufficient products that yield positive externalities?

21. Positive externalities and market failure Outp u t Costs and B e n e fit s Mar g in al Priv a te B e n e fit Marginal Private Cost = Marginal Social Cost Mar g in al Social B e n e fit Q2 Q1 Consumer Surplus Produce r Surplus Equ i libriu m output

22. Positive externalities and market failure Outp u t Costs and B e n e fits Mar g inal Priv a te B e n e fit Marginal Private Cost = Marginal Social Cost Q2 Q1 Consumer Surplus Producer Surplus Equ i libriu m output Gain to other people Marginal Social Benefit

23. Positive externalities and market failure Outp u t Costs and B e n e fits Mar g inal Priv a te B e n e fit Marginal Private Cost = Marginal Social Cost Mar g inal Social B e n e fit Q2 Q1 In a free market consumption will be at Q1 because Demand = Supply (private benefit = private cost )

24. Positive externalities and market failure Costs and B e n e fits Mar g inal Priv a te B e n e fit Marginal Private Cost = Marginal Social Cost Mar g inal Social B e n e fit Q1 Q2 Outp u t However this is socially inefficient because Social Cost < Social Benefit. Therefore there is under consumption of the positive externality

25. Positive externalities and market failure Outp u t Costs and B e n e fits Mar g inal Priv a te B e n e fit Marginal Private Cost = Marginal Social Cost Mar g inal Social B e n e fit Q2 Q1 Social Efficiency would occur at Q2 where Social Marginal Cost = Social Marginal Benefit

26. Positive externalities and market failure Outp u t Costs and B e n e fits Mar g inal Priv a te B e n e fit Marginal Private Cost = Marginal Social Cost Mar g inal Social B e n e fit Q2 Q1 Welfare loss from the good being under-consumed Under-consumption of products with positive externalities leads to a net loss of social welfare – shown in the diagram above

27. Costs and benefits in consumption: External costs in consumption – where MSB < MPB e.g. passive smoking, litter, noise, anti-social behaviour External benefits in consumption – where MSB > MPB e.g. preventative health care – vaccinations, public transport, attractive gardens, bathing regularly! Positive and Negative Externalities

28. External costs – socially efficient output is less than current output External benefits – socially efficient output is greater than current output Socially efficient output is where MSC + MPC = MSB + MPB Positive and Negative Externalities

29. Weighing up the costs and benefits Benefits from production of chemicals/pharmaceuticals and energy Costs of generating these products/services Copyright: Karoly Feher and Drew Broadley, stock.xchng Positive and Negative Externalities