Chapter 16 Externalities
Consumers and producers are internal to a transaction. Consumers receive a benefit from the goods they purchase, while producers pay the costs of production. An externality (sometimes called a spillover) is a cost or benefit that goes to someone external to a transaction. Pollution is a negative (cost) externality. Education and research create a positive externality. Externalities can result from consumption or production.
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An Example:
Suppose that the costs of raising livestock are mostly borne by the rancher, but there is a spillover cost. Streams nearby get polluted, and this affects people (and other species) who use the stream as well as spinach farmers who also use the water for irrigation. Ranchers will consider their own costs of production, but the costs to others could be greater than the surplus from cattle production.
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Negative Externalities
• If there is an external cost from production, the Marginal Social Cost is higher than the producer’s Marginal Cost (competitive Supply). • The competitive equilibrium will produce more than the optimal quantity for Society. • If there is an external cost to consumption, the Marginal Social Value is less than Demand.
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Positive Externalities
• If there is an external benefit from consumption, the Marginal Social Benefit is higher than consumer Demand. • The competitive equilibrium will produce less than the optimal quantity for Society. • If there is an external benefit to production, the Marginal Social Cost is less than Supply.
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Externalities
• Negative Production Externality: MSC higher than Supply, market leads to too much Q. • Negative Consumption Externality: MSB lower than Demand, market leads to too much Q. • Positive Production Externality: MSC lower than Supply, market leads to too little Q. • Positive Consumption Externality: MSB
