Externalities and Marginal Social cost and Marginal Social Benefit MSB = Marginal benefit plus spillover benefit (positive externality) MSC = Marginal cost plus spillover cost (negative externality) Social costs include the total cost/ benefit of the action not just the amount affecting the buyer or seller. Social costs / benefits are equal to the externality. The market will need government intervention to operate at the MSB = MSC point as it will not operate here without regulation or public provision or taxes. Price is determined by the MB curve always

Production graphs Positive externalities result in overpriced goods and an under supply of the product Negative externalities result in under priced goods and over produced goods

Achieving MSB = MSC can require Markets can fix externalities if: Property rights are clearly defined. Ownership of an asset enables you to charge for pollution or damage to an asset by others. Or charge a price to use the asset. Owners want to minimise the damage or maximise revenue from the asset. Externalities occur as property rights are not clear in most areas e.g. who owns the Waikato river?

Internalising a externality Means to limit the impact or remove a externality altogether by the firm or individual. Coase theorem – states if property rights are well defined and transaction costs are low the market can internalise an externality. Pollution rights – government can set allowable standards for pollution similar to quota’s in fishing where these licenses can be traded between business / carbon credits under the Emissions Trading Scheme – legal law for reducing pollution in NZ. Forestry benefits from this scheme and polluters must purchase carbon credits to pollute from the foresters. E.g. Polluter pays principle is applied.

Emission Trading Scheme Law introduced by Labour and made easier on polluters by National, which costs tax payer instead for pollution levels above 1990 levels as based on Kyoto Protocol. Reduced times for entry into the scheme for dairy farmers and electricity companies and petrol tax due to the recession/weak economy.