CAS EC 101 Chapter Notes - Chapter 14: Externality, Economic Surplus, Demand Curve
4 Nov 2016
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• Externalities
o A rational self-interested agent undertaking an economic activity considers
the effect of the activity on his welfare
o The effects on the agent’s welfare are often transmitted through a market
o But an agent may not consider the effects of his activities on other people
o Effects on others that are not considered by rational agents are called
externalities
▪ Ex: flower garden in yard makes neighbors happy, driving causes
pollution, renting to noisy people annoys neighbors
▪ These effects are NOT transmitted through a market
• External Costs and Benefits
o External cost—negative externality on others (noisy concert outside of the
office)
o Positional externality—one person does it, so others feel they must do it to
(arm’s race; girls buy the most expensive prom dress)
o External benefit—positive effect; promoting others to do good with good
behavior (roommate studies, so other roommate will too)
• Positive and Negative Externality
o An activity with an external benefit is said to have a positive externality
o An activity with an external cost is said to have a negative externality
o Externalities create economic inefficiency because when deciding what
activities to pursue, people lack the incentive to consider the externalities
those activities create
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CAS EC 101 Full Course Notes
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