1. Externalities & Market Failure

2. What is an externality?
This arises when a person or firm engages in an activity that influences the well-being of others and yet neither pays nor receives compensation for that effect
Factoring in externalities shows the true costs and benefits to society
Negative Externality
Positive Externality
The activity causes a negative impact on the well-being of society
The activity causes a positive impact on the well-being of society

3. Negative or Positive?

4. Externality Terms Marginal private benefit
The benefit derived by the private consumer

5. Timbers MPB when being a dingus is Barbers enjoyment of his shenanigans

6. Externality Terms Marginal private benefit Marginal private cost
The benefit derived by the private consumer
Marginal private cost
The private cost to the producers of a good associated with the good’s production

7. The MPC of Timber being a dingus could be $10 (for the food, toys, etc

8. Externality Terms Marginal private benefit Marginal private cost
The benefit derived by the private consumer
Marginal private cost
The private cost to the producers of a good associated with the good’s production
Marginal social benefit
The private benefit plus any external benefits placed on society

9. The MSB of Timber being a dingus for Barbers enjoyment of shenanigans AND the happiness he brings from majestic derpiness

10. Externality Terms Marginal private benefit Marginal private cost
The benefit derived by the private consumer
Marginal private cost
The private cost to the producers of a good associated with the good’s production
Marginal social benefit
The private benefit plus any external benefits placed on society (positive externality)
Marginal social cost
The private cost plus any external costs placed on society (negative externality)

11. The MSC of Timber being a dingus is $10 AND the damage done to public grounds from his shedding and pooping

12. Graphing the impact of externalities

14. A market graph

15. A market graph when describing externalities

16. Lets look at the car market
Lets look at the car market. Lets assume that there are NO government regulations on car production…

17. The externalities of car production would create MARKET FAILURE!

18. Sometimes the production of the good produces a cost that is NOT included in the marginal private cost of production

19. For example, when a firm pollutes the air during production, this cost of pollution to society is NOT included in the MPC of production

20. The pollution cost is a negative externality

21. When the pollution cost is added to the MPC of production, you then get the marginal social cost to society

22. So, the marginal social cost is the TRUE cost of producing a car.

23. Externalities and their effects
If unregulated, they cause market failure
Creates deadweight loss
Causes either an over-allocation or under-allocation of resources.
Producing at the socially efficient equilibrium (MSB = MSC) will offset the impact of externalities.

24. Public Policy Towards Externalities
Negative Externalities
Taxes
Limits to production
Regulate production technology
Positive Externalities
Subsidy
Tax breaks
Incentives

25. Negative

26. Positive

27. Higher Education Practice
Higher education causes society to be more productive
Graph the market failure
Is it over or under allocation of resources?