Negative Consumption

Externality
Unit 5 - Lesson 6
Learning Outcomes:
● Define all terms in orange bold for section 5.4. (AO1)
● Explain negative consumption externality and the resulting welfare loss.
(AO2)
● Draw a negative consumption externality diagram and the resulting welfare
loss. (AO4)
● Explain the meaning of a demerit good. (AO4)
● Calculate the welfare loss that arises from a negative consumption
externality. (AO4)
Explain negative consumption externality and the resulting welfare
loss. (AO2)

Negative Consumption Externalities

● Refers to external/additional costs created by consumers.
● Free market over allocates resources to the production of the good. Too
much of the good is being produced relative to what society desires.
● The Quantity produced by the free market is greater than the Quantity
desired by society.
● At the Quantity produced by the free market the MSC (additional cost to
society for the production of an additional unit of output) is greater than the
MSB (additional benefit society receives from consuming one more unit of
output).
Explain negative consumption externality and the resulting welfare
loss. (AO2)
● The over allocation of resources to
the production of the good results in
additional costs/spillover costs to
society that are not accounted during
the private transaction.
○ From the picture to the right the
additional cost are:
■ Cost to non-smokers inhaling
passive smoke.
■ Additional costs to society of
the increased health burden
created by smokers.
Draw a negative consumption externality diagram and the resulting welfare
loss. (AO4)
The diagram to the right represents a
Negative Consumption Externality.

A Negative Consumption Externality

arises when the consumption of a good
results in additional/spillover cost to a 3rd
party or society.

An example of a Negative Consumption

Externality - tobacco smoking.

● Additional costs include passive smoke

and additional cost of healthcare
incurred by society.
Draw a negative consumption externality diagram and the resulting
welfare loss. (AO4)

How to use the graph to explain a

Negative Production Externality - be
sure to follow along on the graph.

● The free market is at equilibrium at

point A where the MPB (the
additional benefit the consumer
receives from consuming an
additional unit of a good) is equal to
MPC (additional cost to the producer
for producing an additional unit of
output) at (Pfm - Qfm).
Draw a negative consumption externality diagram and the resulting welfare loss.
(AO4)

● Society desires Point C where the

MSB (additional benefit to society) is
equal to MSC (additional cost to
society) at (P-so, Q-so).
● Point C is the allocative efficient
quantity of output - Qso.
● At Qfm, MSC (point A) is greater
than MSB (point B) therefore the
market is not allocatively efficient.
● There is an over allocation of
resources to the production of the
good - (Qfm is greater than Qso)
Draw a negative consumption externality diagram and the resulting welfare
loss. (AO4)

● The vertical distance between

MSC (point A) and MSB (point B)
represents the external or
additional/spillover costs
incurred by society from the
private transaction.
● Triangle A, B, C represents the
Total Welfare Loss (TWL) to
society.
○ TWL is the loss of social
benefits due to the
overconsumption of the good
caused by the externality.
Draw a negative consumption externality diagram and the resulting welfare
loss. (AO4)

A Negative Consumption
Externality is a market failure
because of the additional/spillover
costs incurred by society from the
consumption of the good. There is
an over allocation of resources to
the production of the good.
Calculate the welfare loss that results from a negative production
externality. (AO4)

To calculate the Total Welfare Loss

(TWL) find the area of Triangle A, B, C.

Area of a Triangle =

(height (A - B)) X width (Qfm - Qso))

divided by 2
Explain the meaning of a demerit good. (AO4)

Demerit Goods
● Goods that are deemed
undesirable by society and as
such are overproduced.
● Reason for the free market to
overproduce is that the good may
have negative consumption
externalities.
● Examples: cigarettes, alcohol, and
gambling.
Explain that negative production externalities can be used to illustrate
overuse of common pool resources. (AO2)
Negative Production Externalities are more
often associated with depletion of common
pool resources than Negative Consumption.

However Negative Consumption

Externalities can also be used to illustrate the
impact on common pool resources.

Examples: Use of petrol driven vehicles,

consumption of air travel.

The vertical distance between the MSC and

MPC - external/spillover cost to society - such
as global warming, degradation of air or
ozone layer.