Externalities

Discuss an example of a negative production externality (Private benefits/costs and social benefits/costs

- Air pollution from factories - Pollution from fertilizers - Industrial waste - Noise pollution - Collapsing fish stocks - Methane emissions - Congestion on the freeway

Discuss an example of a positive consumption externality (Private benefits/costs and social benefits/costs

- Flu vaccination - Hecs - Solar Panels - Medicare - Childcare - Public Transport

Explain Market model illustrating positive consumption externality

1. Dp represents private benefits and Sp represented private costs 2. Equilibrium is at PeQe 3. But there is an external benefit represented by Ds = Private benefit + external benefit 4. To capture the external benefit, market should produce at Qo and price at Po 5. So optimum equilibrium is Po,Qo (Where S = Ds) 6. Market fails because it under produces, therefore the good is under consumed, causing a DWL (Deadweight loss) 7. DWL: Areas of triangle pointing to the efficient equilibrium point

Explain Market model illustrating negative production externality

1. Dp represents private benefits and Sp represents private costs 2. Equilibrium is at PeQe 3. But there is an external cost represented by Ss = private cost + external cost 4. To capture these external costs, market should produce at Qo (Quantity optimum) and market should price the good at Po (Price optimum) 5. So optimum equilibrium is Po,Qo (Where D = Ss 6. Market fails because it over produces the good, causing a DWL (Deadweight loss) 7. DWL: Areas of triangle pointing to the efficient equilibrium point

Explain Market Model illustrating subsidies

1. Government places a subsidy to consumers equal to the external benefit 2. Subsidy shifts the demand curve from Dp to Ds 3. Price paid by consumers decreases from Pe to P2 and output increases from Qe to Qo 4. Consumers pay less and receive more 5. Government pays (Po-P2) x Qo 6. Deadweight loss is eliminated

Explain Market Model illustrating taxes

1. Government places a tax on the firm equal to the size of the external cost 2. Tax shifts the firms Supply curve from Sp to Ss 3. Decrease S as costs increase for the firm) 4. Tax increases the price of the good from Pe to Po and output decreases from Qe to Qo 5. Firmed are forced to pay the external costs (i.e. the negative externality is internalise) 6. Government gets revenue (Po-P1) x Qo 7. Deadweight loss is eliminated

Define external benefits

Any benefit that accrues to a third party as a result of a market exchange. Benefits to people who are not involved in the business - Car Park External Benefit: Might stop park uses from parking in residents driveways and along the road near their houses

Define external costs

Any cost that a third party accrues as a result of a market exchange. Costs to other people who are not involved in the business. - Car Park External Costs: Loss of land and for local residents - spoil their view.

Define negative production externality

Cost or harmful effects of an activity on a third party - Flight tickets: private costs are fuel, taxes, wages etc. But the market does not take into account the noise pollution which is the private cost of this market exchange

What is the difference between private benefits and private costs?

Flat car park vs. Multi storey car park - Flat car park may be cheaper to build (benefit), but it uses more space (cost) - Multi-storey may be more expensive to build (cost), but it uses less space (benefit)

Define externalities

Market only captures the private costs and benefits. When the market fails to capture the external benefits or costs, and costs these are known as externalities. When they exist, a market is not efficient and fails to produce at optimum quantity. Externalities are spill-over effects arising from production and consumption for which no appropriate compensation is paid. Externalities lie outside the market transaction.

Explain subsidies (Government policy)

Subsides to increase consumption for consumers (positive consumption externalities). Used to internalise the benefits of a positive consumption externality

Show and explain how subsidies (PCE) internalise the externalities

Subsides work to increase consumption of goods with positive externalities e.g. Flu vaccination: Free vaccinations increase consumption and improve wellbeing of population Sometimes the subsidy goes to the producer who then reduces the price of a good e.g. public transport, medication

Explain taxes (Government policy)

Taxes to decrease output of producers (negative production externality). Used to internalise a negative production externality

Show and explain how taxes (NPE) internalise the externality

Taxes work on a polluter pays principle. Firms are motivated to decrease pollution e.g. Cockburn cement: Legislate to charge fines and put restriction on production

Define private costs

The costs to a consumer or firm for a market exchange

Explain Role of Government

To reduce production of goods causing negative production externalities and increase consumption of goods with positive externalities Government policy is to internalise the externality Internalise is to force the market to recognise and include the external cost or external benefit in the market price Government does this through taxes and subsides

Define positive consumption externality

Unintended benefit or spill-over to a third party - Flu Vaccination: Private benefits are being vaccinated against the flu, the external benefits are that others who are not vaccinated will receive a measure of protection if infection cannot spread as easily

Define private benefits

What a consumer or firms benefits from a market exchange