a) Distinction between private costs, external costs and social costs
Negative externality – social costs of an economic action are greater than the private costs
Private costs are costs that occurs to the individual economic agent
External costs are costs that accrue to the third parties that are outside of the decision to consume or produce that good or service
Social costs are the costs to society as a whole and therefore include both the private and external cost
What is the equation for social costs?
Negative Social Costs = Marginal Private Costs + External Costs
What happens if external costs exist?
Marginal social cost will be greater than marginal private cost
What happens if the external cost does not exist?
Marginal social cost will be equal to marginal private cost
Negative externalities exist when MSC > MPC
b) Distinction between private benefits, external benefits and social benefits
Positive externality – social benefits of an economic action are greater than the private benefits
Private benefits are the benefits that occurs to the individual economic agent
External benefits are benefits that accrue to the third parties that are outside of the decision to consume or produce that good or service
Social benefits are the benefits to society as a whole and include both the private and external benefits
Private and External benefit of healthcare and education
What is the equation for social benefits?
Positive Social Benefits = Marginal Private Benefits + External Benefits
What happens if external benefits exist?
Marginal social benefits will be greater than marginal private benefits
What happens if the external benefits do not exist?
Marginal social benefits will be equal to marginal private benefits
Positive externalities therefore exist when MSC > MPC
c) Use of a diagram to illustrate:
The external costs of production using marginal analysis, The distinction between market equilibrium and social optimum position and Identification of welfare loss area
As an external cost exists, the marginal social cost is greater than the marginal private cost
The economic agent under existence of a negative externality only takes into account the marginal private costs and so the good is over produced and over consumed at Q1 at a lower price than P1
Known as the free market or inefficient outputs (try and label)
If the economic agent took into account the external costs, then it would produce and consume at a lower output Qe and a higher price Pe
Known as the socially optimum or efficient output (label)
Welfare loss – overall loss to society of the consumption or production of a good or service
For every unit produced or consumed from Qe to Q1, cost to society (MSC) is greater than the marginal social benefit (MSB). Society essentially loses out. d) Use of a diagram to illustrate:
The external benefits of consumption using marginal analysis, The distinction between market equilibrium and social optimum position and Identification of welfare gain area
Why do the two curves diverge from each other?
MSB is made up of external benefits and MPB so, MPB is separate from MSB
Where is inefficient (free market) output? Why?
Not the maximum to society, only the MPB. Underemployment and under produced
Where is efficient (socially optimum) output? Why?
Where private and external benefits can be taken into consideration
Why is there welfare gain?
Area for where every unit has a greater benefit to society than to private benefits
Solution to correct market failure:
Taxing fast food to make it more expensive
Trying to make fast food healthier
Making expensive food more affordable
Advertisements to deter consumers from purchasing fast food products
Correct externality diagram:
Solution to correct market failure:
Higher taxes on fuels
Parking meters to deter car usage
Promoting electric vehicles
Correct externality diagram:
