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Konstantin Frank

1. With the help of diagrams and suitable examples, explain the concepts of positive and negative externalities of consumption

Negative externalities Marginal Cost Marginal Private Benet Marginal Social Benet

Pe Ps

Qs

Qe

The price equilibrium is at Qe/Pe. The consumption of the product, and the linked satisfaction taken from it (the marginal private benet curve), is not equal to the marginal social benet, so the consumption imposes a cost to society. A good example would be smoking. The person smoking is not only satisfying her own need for cigarettes, but also exposing other people to the smoke, which can cause health issues. The marginal social benet is smaller than the marginal private benet, therefore it is a negative externality caused by consumption. There is an overconsumption of the cigarettes, and it is not an efcient allocation of the resources, therefore it is a market failure.

Konstantin Frank

Positive externalities Marginal Cost Marginal Social Benet Marginal Private Benet

Ps Pe

Qe

Qs

A positive externality caused by consumption would for example be education. I consume education (a service provided by schools, universities, online courses etc.) and society benets from it as well, because I can work more efciently. Therefore, the social benet is bigger than my private benet. There is a welfare loss as more people should study, so an effective allocation of resources is created. On the diagram, one can see that the Marginal Social Benet line is right to the Marginal Private Benet, this shows that the consumption is affecting society in a positive way.

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2. Do you think a tax should be placed on chewing gum consumers? Use a diagram to support your argument.

I am denitely in favor of placing a tax on chewing gums. As their consumption is having a negative effect on the society chewing gum can be considered as a negative consumption externality. A market failure is created as the Marginal Social Benet is smaller than the Marginal Private Benet. This can be seen on the diagram, as the Marginal Private Benet curve is more to the right than the marginal social benet curve. This shows that there is an overconsumption and that resources are not allocated efciently. Moreover the fact that the removal of chewing gum costs more than producing it shows the disequilibrium of the social and private benet. Interesting to know is, that Singapore introduced a law that forbids spitting chewing gum on the street. High nes are applied if one disregards it. A way to

Marginal Production Cost Marginal Social Benet

Marginal Private Benet

Ps P*

Q*

Qs

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eliminate this overconsumption is to advert negatively about chewing gum, which would shift the demand curve, which is equal to the marginal private benet curve, to the left and by imposing tax ,the production cost would rise and a new equilibrium would be formed. This equilibrium would not be any longer Qs/Ps, but closer to Q*/P* and the market failure would be minimized.

3. Dene a public good, a merit good and a demerit good Public good A public good is a product, which is not rivalry and not excludable. Not - rivalry means that if a person consumes this product, there will not be less afterwards and not excludable means that one needs to consume the product and can not live without it. A good example would be air. We all breath air and have to breath air, but by breathing it we do not take away any air from other persons.

Merit good A merit good is a good, that is under provided, desirable and often provided by the government to make sure as many people as possible receive it. Probably the best examples are education and vaccinations. Merit goods merely have positive effects on society and are considered as positive externalities. Its consumption is considered as productive and healthy.

Demerit good A demerit good is a good, that is over provided and most of the time harmful for society. It will be over consumed in the free market and they are often regulated or limited by the government. Their consumption is considered as unhealthy and unproductive.

Konstantin Frank

Explain with the help of examples, how under provision of public and merit goods, and over provision of demerit goods creates market failure

As I understood the concept of externalities and therefore also merit and demerit goods it states that there could be more. This is exactly what happens with merit goods and why they are often under provided. Theoretically everybody should get merit goods and needs them, but there is an unequal distribution of them. A good example would be water. We use several hundreds of liters of water every day to shower, cook, wash etc. while people in Africa die of thirst. This is a wrong allocation of resources and a market failure. An example, why the over provision of demerit goods is causing a market failure, would be the consumption of illegal drugs like marihuana. The effectivity of a person gets limited when she/he consumes marihuana and his work force is not efciently used and therefore creating a market failure.

Use the table below to summarize the types of market failure covered in weeks 11 and 12

Type

1. Negative 2. Positive 3. Negative 4. Positive externalities of externalities of externalities of externalities of consumption consumption production production Negative externalities of consumption, cause that the consumption of a product leads to a situation, where society has to pay partially the cost of the consumption Positive externalities of consumption cause that the consumptino of a product leads to a situation, where society benets from the consumption Negative externalities of production cause that the production of a product leads to a situation where society has to pay an extra cost for the production Positive externalities of consumption cause that the production of a product leads to a situation where society has a benet from it.

Description

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Type

1. Negative 2. Positive 3. Negative 4. Positive externalities of externalities of externalities of externalities of consumption consumption production production Consumption of drugs like alcohol or tobacco Education Generating electricity by using nuclear plants Landscaping a garden

Examples

Diagram Solutions Banning or limiting the consumption Making more education available (affordable for more people) tradable pollution rights, limitations, taxes subsidies

Problems with solutions

Creating a black market , hard to control, banning can cause many people to loose their job (tobacco industry)

very expensive, Hard to opportunity cost calculate how high the taxes, punishments etc. should be, tradable pollution rights can be used to extend pollution by rich companies http:// www.businessstandard.com/ india/news/ steerclearaviationsector/457472/ http:// www.aljazeera. com/indepth/ opinion/ 2011/12/201112 614332734768. html

very expensive, opportunity cost

In the news

http:// www.nst.com.m y/opinion/ columnist/ counting-thecost-of-trafcjams-1.18661

http:// www.cleveland. com/opinion/ index.ssf/ 2011/12/ demand_for_oh io_mass_transit _p.html

Konstantin Frank

Marginal Cost

Marginal Private Benet

Marginal Social Benet

Negative externalities of consumption

Marginal Cost

Marginal Social Benet

Marginal Private Benet

Positive externalities of consumption

Konstantin Frank

Negative externalities of production

Konstantin Frank

Marginal Production Cost

Marginal Social Cost

Marginal Social Benet

Positive externalities of production