Externalities Economics

Negative Production Externalities Explanation

- Dp represents private benefits and Sp represents private costs - Equilibrium is at PeQe - But their is an external cost represented by Ss (= private cost + social costs) - To capture these external costs market should produce at Qo (Qty optimum) & market should price the good at Po (Where D = Ss) - Market fails because it overproduces the good causing a DWL (Deadweight Loss)

Positive Consumption Externalities Explanation

- Dp represents private benefits and Sp represents private costs - Equilibrium is at PeQe - But there is an external benefit presented by Ds = (private + external benefit) - To capture the external benefit market should produce at Qo and price at Po - So optimal equilibrium is PoQo (Where S = Ds) - Market fails because it underproduces, therefore the good is under consumed causing a DWL (Deadweight loss)

Subsides Definition

- Government places a subsidy to consumers equal to the external benefit - Subsidy shifts the D curve from Dp to Ds - Price paid by consumers decreases to P2 and output increases to Qo - Consumers pay less and receive more - Government pays (Po - P2) x Qo - Dwl is eliminated

Taxes Explanation

- Government places a tax on the firm equal to the size of the external cost - Tax shifts the firms S curve from Sp to Ss (decrease S as costs increase for the firm) - Tax increases the price of the good to Po and output decreases from Qe to Qo - Firms are forced to pay the external costs i.e. the negative externality is internalised - Government gets revenue (Po - P1) x Qo

Externalities and Market Failure

- are spill over effects arising from production ad consumption for which no appropriate compensation is paid - Externalities lie outside the market transaction - Externalities cause market failure if the price mechanism does not take account of the social costs and social benefits of production and consumption - They can be positive and/or negative

Other Government Policies

- fines - restricting production and/or consumption of a good - provide information through government advertising - Legislation - Financial incentives - Direct government provision

Externalities

- market only captures the private costs and benefits - When the market fails to capture the external benefits and costs these are known as externalities - When they exist , a market is not efficient and fails to produce at optimal quantity - Externalities are an unintended consequence of a market activity on a third party. Also known as a spillover or side effect.

Subsidies definition

To increase consumption for consumers (positive consumption externalities)

External Cost

Any benefit that acrues to a third party as a result of a market exchange

External Benefit

Any cost that a third party acures as a result of a market exchange

Negative Externalities

Cost or harmful effects of an activity on a third party eg: Flight tickets or Cockburn Cement

Case Studies

Negative production externality: Cockburn Cement, Flight tickets Postive consumption externality: Gym Membership, Flu vaccinations

Role of Government

Reduce production of goods causing negative production externalities and increase consumption of goods with positive externalities In other words, government policy should 'internalise' the externality (or force the market to recognise and include the external cost or external benefit in the market price

Gym Membership: (Social & Private Benefits)

Social: Employer gets a healthier, fitter worker who is more productive so society benefits Private: Improve your health and overall wellbeing Produced globally, sold to consumers wanting to travel

Flight Tickets: (Social & Private Benefits)

Social: Noise pollution Private: Fuel, taxes, wages etc Produced globally, sold to consumers wanting to travel

Private Cost

The costs to a consumer or firm for a market exchange

Taxes definition

To decrease output of producers (negative production externalities)

Positive Externalities

Unintended benefit or spillover to a third party eg: Flu vaccination or Gym Membership

Taxes

Used to internalise a negative production externality Example - Tax on cigarettes Taxes work on a 'polluter pays' principle. Firms are motivated to decrease pollution

Subsidies

Used to internalise the benefits of a positive consumption externality Example - hecs, subsidising solar panels, medicare, childcare, flu vaccinations. - Sometimes the subsidy goes to the producer who then reduces the price of the good e.g. public transport - Subsidies work to increase consumption of goods with positive externalities

Private Benefit

What the consumer or firm gets from a market exchange