Introduction into Externalities

By: Renee Williams

Causes and Consequences of External Costs and External benefits
 Let's take an example of antibiotics
The rise of the superbugs
Before antibiotics people died from just a simple cut especially
soldiers at war not because of the cut but due to the infection that
would result from the cut.
Now thanks to antibiotics, infections can be fought off easily and
save lives. However, the era of that is coming to an end as
antibiotics are not as effective as they once were.
No antibiotic is 100% effective, bacteria like people are diverse and
the bacteria that aren’t killed pomegranate and become more
dominant.
 Antibiotics are overused
Users get all the benefits but do not bear all the costs.
Each use of antibiotic:
Creates a small increase in bacterial resistance
Pollutes the environment with more stronger resistant bacteria
Antibiotic users ignore these external costs of their choice
Since some choices are ignored by decision makers we get overuse
 Some Key terms
Private cost - the cost paid by the consumer or producer
External costs - cost paid by bystanders, by people other than the
consumer or producer
Social cost - the cost to everyone: the private cost + external cost
Externalities - external costs or external benefits, costs or
benefits that fall on bystanders
Externalities- Consumer and Producer surplus
Free market maximizes consumer surplus + producer surplus.
An external costs is a cost that falls on bystanders not on producers or
consumers.
Social surplus = producer surplus + consumer surplus + bystander
surplus
When there are significant external costs or (benefits) social surplus
will not be maximized
 Conclusions
When there are external costs output should be reduced to maximize social surplus

For determining the efficient level of output who bears the cost is irrelevant

When other people bear the costs of production the price is to low and antibiotic
uses purchase to many antibiotics.

Solution:

Pigouvian tax - a tax on a good with external costs.

Pigouvian tax
 References
Corporate Finance Institute. (2021, January 30). Externality.
https://corporatefinanceinstitute.com/resources/knowledge/economics/externality/

External Effects. (2006, July 5). Saylor.Org.

https://saylordotorg.github.io/text_introduction-to-economic-analysis/s08-01-external
-effects.html

Marginal Revolution University. (2015, March 18). An Introduction to Externalities.

YouTube. https://www.youtube.com/watch?v=CpVf11f09Pk

Pettinger, T. (2020, October 3). External Benefits. Economics Help.

https://www.economicshelp.org/blog/glossary/external-benefits/
 Question & Answer Session
1. What are the different types of externalities?
There are only two types of externalities and they can either be
positive or negative.
2. Are externalities linked to market failure?
Yes, they are linked to market failure as they are spillover effects
that can happen as a result of market failure and are sometimes used
interchangeably with demerit and merit goods.
3. Does externalities affect the consumer or producer?
No it does not as the external cost or benefit falls on someone
outside of the consumer producer transaction process.