1. Positive and negative externalities in consumption and production
Market Failure
Positive and negative externalities in consumption and production

2. Definition
When the free market mechanism leads to a misallocation of resources in the economy, either completely failing to provide a good or service or providing the wrong quantity.

3. Market failure Negative externalities Positive externalities
Merit & demerit goods
Public goods
Monopoly
Immobility of the factors of production
Unequal distribution of income and wealth

4. Negative externalities
Also regarded as the external cost. When the consumption or production of a good or service causes costs to a third party, where the social cost is greater than the private cost.

5. Negative externalities1
Costs that spill over to third parties of a market transaction.

6. Production needs to be reduced.
Negative externalities in production Where the social cost of production exceeds the private cost
Costs and benefits
The existence of negative externalities in production creates a divergence between the private and social costs of production. The private costs of any action are those incurred by the individual decision maker while the social costs of the corresponding action are ALL the conceivable costs associated with the action.
Production needs to be reduced.
S2 (MSC)
S1 (MPC) P2 E2 P1 E1
D (MSB) Q2 Q1
Quantity

7. Negative externalities in consumption Where the social cost of consumption exceeds the private cost
The existence of negative externalities in consumption creates a divergence between the private and social costs of consumption. The private benefits of any action are those incurred by the individual decision maker while the social benefits of the corresponding action are ALL the conceivable benefits associated with the action. Consumption needs to be reduced.
Costs and benefits
S (MSC) E1 P1
D1 (MPB) P2 E2
D2 (MSB) Q2 Q1
Quantity

8. Positive externalities
Also regarded as the external benefit. When the consumption or production of a good or service results in a third party benefit, where the social benefit is greater than the private benefit .

9. Positive externalities2
Benefits that spill over to third parties of a market transaction.

10. Production needs to be increased.
Positive externalities in production Where the social benefit of production is greater than the private benefit
Costs and benefits
The existence of positive externalities in production creates a divergence between the private and social costs of production. The private costs of any action are those incurred by the individual decision maker while the social costs of the corresponding action are ALL the conceivable costs associated with the action.
Production needs to be increased.
S1 (MPC)
S2 (MSC) P1 E1 P2 E2
D (MSB) Q1 Q2
Quantity

11. Positive externalities in consumption Where the social benefit of consumption is greater than the private benefit
The existence of positive externalities in consumption creates a divergence between the private and social costs of consumption. The private benefits of any action are those incurred by the individual decision maker while the social benefits of the corresponding action are ALL the conceivable benefits associated with the action. Consumption needs to be increased
Costs and benefits
S (MSC) E2 P2 P1 E1
D2 (MSB)
D1 (MPB)
QDS1
QDS2
Quantity