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0. Basic Principles of Economics1h 5m
1. Reading and Understanding Graphs59m
2. Introductory Economic Models1h 10m
3. The Market Forces of Supply and Demand2h 26m
4. Elasticity2h 26m
5. Consumer and Producer Surplus; Price Ceilings and Floors3h 45m
6. Introduction to Taxes and Subsidies1h 46m
7. Externalities1h 12m
8. The Types of Goods1h 13m
9. International Trade1h 16m
10. The Costs of Production2h 35m
11. Perfect Competition2h 23m
12. Monopoly2h 13m
13. Monopolistic Competition1h 9m
14. Oligopoly1h 26m
15. Markets for the Factors of Production1h 26m
16. Income Inequality and Poverty35m
17. Asymmetric Information, Voting, and Public Choice39m
18. Consumer Choice and Behavioral Economics1h 16m

7. Externalities

Externalities: Social Benefits and Social Costs

7. Externalities

Externalities: Social Benefits and Social Costs: Videos & Practice Problems

Video Lessons Practice Worksheet

Topic summary

Externalities are costs or benefits imposed on innocent bystanders not involved in a transaction. Negative externalities, like pollution from a factory, lead to overproduction and market failure, while positive externalities, such as education, result in underproduction. The marginal social cost (MSC) and marginal social benefit (MSB) curves illustrate these concepts, highlighting the need for efficient market outcomes. Property rights play a crucial role in internalizing externalities, influencing how costs and benefits are distributed within society.

Have you ever considered if your purchases have effects on others? There may be costs or benefits you're not considering!

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Negative Externality and Positive Externality

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Negative Externality and Positive Externality Video Summary

Externalities are important concepts in economics that extend the idea of costs and benefits beyond just the buyer and seller in a transaction to include the entire society. They can be classified into two main types: negative externalities and positive externalities. Understanding these concepts helps us recognize how individual actions can impact innocent bystanders who are not directly involved in a transaction.

A negative externality occurs when a transaction imposes a cost on third parties. For instance, consider a paper production factory that discharges pollutants into a nearby lake. The private costs for the factory include expenses related to cutting down trees and processing them into paper. However, the pollution affects local residents, imposing an external cost on them. This leads to the concept of social cost, which combines the private cost with the external cost, represented by the Marginal Social Cost (MSC) curve. The MSC reflects the true cost of production to society, including both the costs incurred by the producer and the costs imposed on others.

On the other hand, positive externalities create benefits for bystanders. For example, when individuals receive vaccinations, they gain the private benefit of protection from disease. However, their vaccination also contributes to herd immunity, reducing the likelihood of disease spread in the community. This external benefit is captured in the Marginal Social Benefit (MSB) curve, which includes the private benefit plus the additional benefits to society.

Both negative and positive externalities highlight the importance of considering the broader implications of economic transactions. While negative externalities can lead to societal costs, positive externalities can enhance overall welfare. However, quantifying these external costs and benefits can be challenging, as they often involve intangible factors such as happiness or public health. Understanding these dynamics is crucial for addressing externalities effectively in economic policy and decision-making.

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Externalities on the Graph

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Externalities on the Graph Video Summary

Externalities are significant economic concepts that can lead to market failures, impacting both production and consumption. A negative externality occurs when a company's actions impose costs on others without compensation. For instance, consider a paper production company that discharges pollutants into a lake, affecting the quality of life for nearby residents. In this scenario, the supply curve (S1) reflects the private costs of production, such as raw materials and labor, but does not account for the external costs of pollution. This results in an equilibrium quantity (QM) that is higher than the socially optimal quantity (Q*), leading to overproduction and a deadweight loss due to inefficiencies in the market.

To visualize this, the marginal social cost (S2) curve incorporates the external costs, shifting the supply curve leftward to reflect the true cost of production. The efficient equilibrium occurs where the marginal social cost intersects with the demand curve, indicating the quantity that accounts for both private and external costs. The deadweight loss is represented by the area between the marginal social cost and the market equilibrium, highlighting the inefficiencies caused by the negative externality.

Conversely, positive externalities arise when a product or service provides additional benefits to society beyond the individual consumer. A prime example is education, which not only benefits the individual but also enhances societal productivity. In this case, the demand curve shifts to the right (D2) to reflect the additional social benefits of education, leading to an equilibrium quantity (Q*) that is higher than the market quantity (QM). This underproduction indicates that the market fails to provide enough education, resulting in another form of deadweight loss.

Both types of externalities illustrate how markets can fail to achieve efficient outcomes. The existence of externalities often stems from poorly defined or unenforced property rights. For instance, if the paper company owns the lake, it may legally pollute without repercussions. However, if the residents own the lake, they can negotiate compensation for pollution, internalizing the external costs and moving towards a more efficient outcome. Thus, clearly defined property rights are crucial in addressing externalities and achieving market efficiency.

Problem

If the production of a good causes a negative externality, then the social-cost curve will lie the supply curve, and the socially optimal quantity is _ than the equilibrium quantity.

Above; Greater

Above; Less

Below; Greater

Below; Less

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Here’s what students ask on this topic:

What are externalities in economics?

Externalities are costs or benefits that affect third parties who are not directly involved in a transaction. They can be either negative or positive. Negative externalities, such as pollution from a factory, impose additional costs on society, leading to overproduction and market inefficiency. Positive externalities, like education, provide additional benefits to society, resulting in underproduction if left to the market alone. Understanding externalities is crucial for addressing market failures and achieving efficient outcomes.

How do negative externalities lead to market failure?

Negative externalities lead to market failure by imposing additional costs on innocent bystanders that are not reflected in the market price. For example, a factory that pollutes a lake imposes a cost on nearby residents. This results in overproduction because the market equilibrium does not account for the external costs. The marginal social cost (MSC) curve, which includes both private and external costs, shows that the true cost of production is higher than the private cost, leading to inefficiency and deadweight loss.

What is the difference between private cost and social cost?

Private cost refers to the costs incurred by the producer or seller in a transaction, which are typically represented by the supply curve. Social cost, on the other hand, includes both the private cost and any external costs imposed on society. The social cost is represented by the marginal social cost (MSC) curve, which accounts for the total cost to society, including negative externalities like pollution. Understanding the difference helps in identifying market inefficiencies and the need for regulatory interventions.

How do positive externalities affect market outcomes?

Positive externalities result in benefits to third parties not directly involved in a transaction. For instance, education not only benefits the individual but also society by creating a more productive population. However, the market tends to underproduce goods with positive externalities because the private benefits do not capture the full social benefits. The marginal social benefit (MSB) curve, which includes both private and external benefits, shows that the true benefit to society is higher than the private benefit, leading to underproduction and inefficiency.

What role do property rights play in addressing externalities?

Property rights are crucial in addressing externalities because they help internalize external costs and benefits. When property rights are clearly defined and enforceable, parties can negotiate to reach an efficient outcome. For example, if residents own a lake, they can negotiate with a polluting factory to compensate for the pollution. This internalizes the external cost, aligning private costs with social costs. However, when property rights are unclear or difficult to enforce, externalities persist, leading to market failures.