Negative Externalities in Production & Consumption Flashcards
(28 cards)
What is a negative externality?
A negative externality is a cost imposed on third parties who are not directly involved in an economic transaction.
What is a negative externality in production?
It occurs when a producer’s activities impose costs on third parties (e.g., pollution, deforestation, resource depletion).
What is a negative externality in consumption?
It occurs when a consumer’s actions impose costs on others (e.g., second-hand smoke, traffic congestion).
Give three examples of negative externalities in production.
Air pollution from factories
Resource depletion (e.g., overfishing)
Deforestation affecting local communities and ecosystems
How do negative production externalities lead to market failure?
Social costs (MSC) exceed private costs (MPC), leading to overproduction and a misallocation of resources.
How are negative production externalities shown on a diagram?
The Marginal Social Cost (MSC) curve lies above the Marginal Private Cost (MPC) curve.
The market equilibrium occurs where MPB = MPC, but the socially optimal output is where MPB = MSC.
This results in overproduction and a welfare loss.
What does it mean if MSC > MPC?
There are external costs being imposed on society, which the producer does not account for — indicating a negative externality.
What is the welfare loss triangle in a negative externality diagram?
It shows the loss of economic efficiency when the market overproduces due to unaccounted social costs.
What does MSC stand for?
Marginal Social Cost – the total cost to society of producing one more unit, including external costs.
What does MPC stand for?
Marginal Private Cost – the cost to the producer of producing one more unit, excluding external costs.
What does MPB = MSB = D mean on a diagram?
It means Marginal Private Benefit equals Marginal Social Benefit, which is represented by the demand curve.
Where does the free market allocate resources?
At the private optimum, where MPB = MPC.
Where is the socially optimal level of output?
Where MSC = MSB (or MPB) – this reflects the allocatively efficient level of production.
What is the welfare loss triangle?
The triangle between MSC and MPC, from the social optimum to the private optimum. It shows the loss of social welfare due to overproduction.
Why does overproduction occur in the presence of negative externalities?
Because producers only consider private costs (MPC) and ignore external costs, leading to a misallocation of scarce resources.
How does this cause allocative inefficiency?
The market produces more than the socially desirable quantity (Q*), meaning resources are not allocated where they provide the most benefit relative to cost.
What is a negative externality in consumption?
A cost to third parties resulting from an individual’s or consumer’s actions, not reflected in market prices.
Give three examples of negative externalities in consumption.
Smoking – affects bystanders through second-hand smoke.
Excessive alcohol consumption – leads to public disorder, burdening police and NHS.
Sugary drinks or fast food – increase obesity-related health issues, raising healthcare costs.
How is a negative consumption externality shown on a diagram?
MSB < MPB, so the MSB curve lies below the MPB curve.
Consumers overconsume at the private optimum where MPB = MSC.
Social optimum is where MSB = MSC.
Welfare loss is shown by the triangle between the private and social optimum.
Why do negative consumption externalities cause market failure?
Consumers only consider their private benefit (MPB) and ignore external costs, leading to overconsumption and allocative inefficiency.
What does MSB = MPB + EB mean?
Marginal Social Benefit equals the Marginal Private Benefit plus (or minus) any external benefit (or cost). For negative externalities, EB is negative.
What is the result of ignoring external costs in consumption?
Society bears additional costs, output exceeds the socially optimal level, and a welfare loss occurs due to misallocation of resources.
Where does the market allocate resources when negative consumption externalities exist?
At the private optimum (Qp, Pp), where MPB = MPC, ignoring social costs.
Where would society prefer resources to be allocated?
At the social optimum (Qs, Ps), where MSB = MSC, accounting for external costs.
