Externalities in Our Lives
Externality- is a cost or benefit that arises from production and falls on
someone other than the producer, or a cost or benefit that arises from
consumption and falls on someone other than the consumer.
Four different types
o Negative production externalities
o Negative consumption externalities
o Positive production externalities
o Positive consumption externalities.
Negative production Externalities
Congestion- traffic on the highway, the costs of congestion are time costs
and fuel costs. This is a cost of a negative production externality.
Pollution and Carbon emissions- Economic activity, pollutes the air, water,
and land, and these individual areas of pollution interact through the eco
system. Air pollution is getting worse. Pollution causing holes in the ozone
and global warming.
o The dumping of industrial waste and untreated sewage and the runoff
from fertilizers pollute oceans, lakes and rivers. This can be
eliminated by by using chemical process to eliminate waste, or land
sites for storage of secure containers.
o Land pollution occurs from umping products.
Negative Consumption Externalities
A source of irritation for most of us, smoking is an example of a negative
To deal with this problem in many public places smoking is banned and there
are limits on smoking.
This imposes a negative consumption externality on smokers.
Noisy parties and outdoor rock concerts are other examples of negative
consumption externalities. Simple ban on parties is not a solution as it avoids
the external cost of sleep-seeking neighbors, but it results in the sleepers
imposing an external cost on the party seekers.
Positive Production Externalities
If a honey farmer places beehives beside an orange growers orchard, two
positive production externalities arise.
The honey farmer gets a positive production externality from the orange
grower because the bees collect pollen and nectar from orange blossoms.
And the orange grower gets a positive production externality because the
bees pollinate the blossoms.
Positive Consumption Externalities
Flu vaccinations generate positive consumption externalities. When you get
the shot you lower the risk of getting the infection, now since you have your
shot and can avoid the flu, your neighbor has a better chance at avoiding it
too. Negative Externality: Pollution
A private cost of production is a cost that is borne by the producer of a good
Marginal cost is the cost of producing an additional unit of a good or service.
Marginal Private cost (MC)- is the cost of producing an additional unit of a
good or service that is borne by its producer.
An external cost is a cost of producing a good or service that is not borne by
the producer but borne by other people.
Marginal External Cost- is the cost of producing an additional unit of a good
or service that falls on people other than the producer.
Marginal Social Cost (MSC)- is the marginal cost incurred by the producer
and buy everyone else on whom the cost falls- by society. It is the sum of
marginal private cost and marginal external cost
o MSC=MC + Marginal External Cost.
o We express cost in dollars but we must remember that cost is an
opportunity cost ex clean air or a clean river is given up to get
Valuing an External cost- Economists use market prices to put a dollar
value on the cost of pollution. Ex- two similar rivers, one polluted the other
clean, 500 homes are built along the side of each river. The homes on clean
river rent for 2500, and the homes beside the polluted river rent for 1500.
With 500 homes on the polluted river the external cost of pollution is
500,000 a month.
External Cost and Output- (Fig 16.1 shows relationship of quantity of
chemical produced and the cost of the pollution it creates)
o The marginal cost curve describes the marginal private cost borne by
the firms that produce the chemical. Marginal cost increases as the
quantity of chemical produced increases.
o If firms dump waste into the river they impose an external cost that
increases with the amount of chemical produced.
o MSC is found by adding the marginal external cost to the marginal
private cost. Ex business produces 4000 tones of chemical a month, its
marginal private cost is 100 and marginal external cost is 125, so
marginal cost is 225 a tonne.
o When quantity of a chemical produced increases the external cost of
Production and Pollution how much?
When an industry is unregulated and free to pollute the amount of pollution
it creates depends on market equilibrium price and quantity of the good
In fig 16.2 the demand curve for a pollution creating chemical is D. This curve
also measures the marginal social benefit, MSB