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Externalities in Production and Consumption:
± Positive ± Negative
Public goods Merit goods Demerit goods Market imperfections Inequalities in:
± Wealth distribution ± Income distribution
Externalities
Externalities result from differences between private and social costs or benefits Externalities can be positive or negative:
± Positive ± these have beneficial effects on 3rd parties ± Negative ± these are costs that incurred by 3rd parties
Negative externalities
If you consider private costs then they would supply along supply curve S Negative externalities mean that social costs are higher so the new supply curve should be S1 and equilibrium moved to P1
Externalities
The presence of negative externalities is likely to cause over production of a product The presence of positive externalities is likely to lead to under production of a product Externalities can lead to market failure if the pricing mechanism fails to account for the social costs and benefits of production
Value of Externalities
The value of social costs and benefits can be measured by looking at:
± Consumer surplus ± Producer surplus ± Cost-benefit analysis : what is the balance of costs and benefits ± Willingness to pay
Public Goods
These are services that are provided by the government Pure public goods have the following characteristics:
± Non excludability ± everyone can consume the goods whether they pay or not ± Non rivalry in consumption ± consumption by one person doesn¶t reduce consumption for others
Private goods
Private goods have the following characteristics:
± Excludability ± if you don¶t pay you can be excluded from consuming the product ± Rivalry ± the consumption of one person reduces the amount available for others to consume ± Rejectability ± you can choose not to consume them and therefore reject them
Merit goods
Merit goods are where social benefits exceed social costs ± they generate positive externalities Governments aim to provide more of these goods due to the benefits to society They may subsidise the production of such goods reducing the marginal costs of consumption and therefore increasing demand Examples ± healthcare, education
Demerit goods
Demerit goods are where social costs outweigh social benefits ± they generate negative externalities Governments try and reduce the consumption of these goods through higher taxes Examples ± cigarettes, alcohol
Market imperfections
Monopolies ± these are often viewed as allocating resources inefficiently as the producer is able to charge higher prices due to being the only producer in the market Imperfect knowledge of the market can also cause market failure
Inequalities
In market economies an individuals ability to consume goods and services is dependent on their income / wealth An uneven distribution of income / wealth within an economy can result in an unsatisfactory allocation of resources and therefore market failure In many developing countries income inequality is great therefore resulting in misallocation of resources
Summary
Externalities are caused when social benefits / costs are different to private benefits / costs Positive externalities occur where social benefits are greater than private benefits Negative externalities occur where social costs are greater than private costs Cost benefit analysis looks at the costs and benefits of producing / consuming a product Public goods are goods that are provided by the government e.g. street lighting Merit goods are where social benefits exceed social costs e.g. healthcare the government encourages people to use these Demerit goods are where social costs exceed social benefits e.g. smoking the government discourages people to use these through taxation Market imperfections can be caused by monopolies, imperfect market knowledge and factor immobility which can result in misallocation of resources Inequalities in wealth and income distribution may result in a misallocation of resources as the rich consume more