Lecture Notes: Negative Externalities of Consumption

Introduction

• Series: Lecture on different types of market failure
• Topic: Negative externalities of consumption
• Definition Review: Market failure - When free market equilibrium quantity is greater or less than the socially optimal level of output.

Recap of Previous Lesson

• Example: Marginal social costs of coal production > Marginal Private costs
• Outcome: Overallocation of resources towards coal electricity.

Today's Focus: Negative Externalities of Consumption

Definition

• Negative externality of consumption: Private benefits of consumers > Social benefits of consumption
  • Spillover Costs: Costs borne by society as a whole.

Example: Alcohol Consumption in Tourist Destinations

• Scenario: British tourists consuming alcohol in Greek islands.
• Spillover Costs: Impacts on local communities
  • Vandalism, crime, traffic accidents, increased need for police/emergency services, noise pollution.

Graphical Analysis

• Demand (MPB): Marginal Private Benefit (enjoyment by tourists)
  • High Private Benefit: Tourists on vacation.
• Supply (MSC): Marginal Social Costs of alcohol consumption.
• Equilibrium: Where MPB = MSC without government intervention
  • Private Benefit > Social Benefit: Overconsumption at equilibrium quantity (Qe).

Identifying Spillover Costs

• Social Benefits (MSB): Benefit to society < Private Benefit.
• External Costs: Difference between MPB and MSB
  • Represented as the distance on the graph.
• Socially Optimal Consumption (Qso): Intersection of MSC and MSB
  • Outcome: Reduces external costs.

Government Intervention: Corrective Tax

• Purpose: To reduce consumption to socially optimal level (Qso).
• Mechanism: Tax on alcohol
  • Impact: Decreases supply, raises price, lowers quantity consumed.

Broader Examples

• Cigarettes: Negative spillover costs on nonsmokers
• General Principle: Overallocation of resources when private benefits lead consumption decisions.

Welfare Analysis

• Without Tax: Overconsumption at Qe, Price Pe
  • Welfare Loss: Triangle representing deadweight loss due to overconsumption
• With Tax: Supply shifts left, reduces welfare loss, aligns quantity with Qso.

Conclusion

• Negative Externalities of Consumption: Addressed by corrective taxes, aligning private consumption with social optimal levels.
• Next Topics: Positive externalities of production and consumption.