Negative Production Externality

1. Market Equilibrium / What the Market wants?

The market will choose the output level Qmarket where private cost=private value.
- This is found where the Supply( private cost) curve intersects with Demand curve
(private value).

2. What Society wants?

The social optimum output level is Qoptimum where social cost = Private or social value.
- The social optimum output level is where total surplus is maximized.
- This is found where the social cost curve intersects with demand curve

3. The Problem of Negative Production Externality

1 Social cost > Private cost because of externality.

Or Social cost > social or private value

2 Qmarket > Qoptimum.

There is a problem of overproduction of optimal level of output/what is socially

undesirable.

4. Conclusion:

1. The market is inefficient because overproduction of what is socially undesirable.

2. Society suffers Deadweight loss which reduces the total social welfare of the
society.
 Positive Production Externality

S
Price Private cost

S
Social cost

D
private
value Quantity

Qmkt Qopt

1. Market Equilibrium/ What Market wants? - as above

2. What Society wants? - as above

3. Problem of Positive Production Externality

1. Private cost > Social cost but Social/private value > social cost

2 Qmarket < Qoptimum.

There is a problem of underproduction of what is socially desirable.

Conclusion:

1. The market is inefficient because underproduction of what is socially desirable.

2. Society suffers Deadweight loss which reduces the welfare of the society
Negative Consumption Externality

Price
S
private cost

D
private
value
D
social value
Quantity
Qopt Qmkt

1. Market Equilibrium / What Market wants? - as above

2. What Society wants? - as above

3. Problem of Negative Consumption Externality

1 Private value > Social value. Because of externality – bad effect

2. Qmarket > Qoptimum.

There is a problem of over consumption of what is socially undesirable.

Conclusion:

1. The market is inefficient because of over consumption of what is socially undesirable.

2. Society suffers Deadweight loss which reduces the welfare of the society
Positive Consumption Externality

1. Market Equilibrium / What Market wants? - as above

2. What Society wants? - as above

3. Problem of Positive Consumption Externality

1. Social value > Private value

2. Qmarket < Qoptimum.

There is a problem of underconsumption of what is socially desirable.

Conclusion:

1. The market is inefficient because of underconsumption of what is socially desirable.

2. Society suffers Deadweight loss which reduces the welfare of the society
APPROACH TO UNDERSTANDING EXTERNALITIES

1. Production externalities

A 2 types: 1 negative 2. positive

B Analyse supply curves

Compare

1. What market wants vs What society wants

2. Social cost vs private cost

3. Qmkt vs Q optimum

4 Problem of overproduction of what is socially undesirable

(negative production externalities)

Problem of underproduction of what is socially desirable

(positive production externalities)

1I. Consumption externalities

A 2 types: 1 negative 2. positive

B Analyse demand curves

Compare

1. What market wants vs What society wants

2. Social value vs private value

3. Qmkt vs Q optimum

4. Problem of overconsumption of what is socially undesirable

(negative consumption externalities)

problem of underconsumption of what is socially desirable

(positive consumption externalities)