Negative Externalities in Economics

Definition

• Negative externalities are costs incurred by third parties due to the actions of another agent.
• There are two types:
  • Production: Costs arising from production activities.
  • Consumption: Costs arising from consumption activities.

Negative Externalities in Production

• Definition: Costs to third parties from producers’ actions.
• Examples:
  • Air Pollution: From industries like metals, textiles, chemicals causing health issues to local residents.
  • Resource Depletion: Future generations suffer from loss of income and resources.
  • Resource Degradation: Waste production affecting local water bodies, endangering public health.
  • Deforestation: Affects villagers relying on forests for resources, increases flooding risks.

Diagram Representation

• Marginal Social Cost (MSC) > Marginal Private Cost (MPC)
  • Social Cost Equation: Private Costs + External Costs
  • Impact: External costs make social costs higher than private costs.

Market Allocation

• Private Optimum: Where MPC = Marginal Private Benefit (MPB)
• Social Optimum (Allocative Efficiency): Where MSC = Marginal Social Benefit (MSB)
• Result: Misallocation of resources, overproduction, and welfare loss.
  • Welfare Loss Identification: Triangle pointing towards social optimum.

Analysis

• Firms ignore full social cost due to self-interest, focusing on private costs.
• Low prices encourage overproduction and consumption, worsening the issue.

Negative Externalities in Consumption

• Definition: Costs to third parties from consumers’ actions.
• Examples:
  • Smoking: Passive smoke affects bystanders' health.
  • Alcohol Consumption: Burdens health and police services.
  • Sugary/Fast Foods: Increases healthcare costs due to obesity.

Diagram Representation

• Marginal Social Benefit (MSB) < Marginal Private Benefit (MPB)
  • Reason: Negative external benefits from consumer actions.

Market Allocation

• Private Optimum: Where MPC = MPB
• Social Optimum: Where MSB = MSC
• Result: Misallocation, overconsumption, and welfare loss.
  • Welfare Loss Identification: Triangle pointing to social optimum.

Analysis

• Consumers focus on private benefits, neglecting full social benefits.
• Results in excess resource allocation to undesired markets, causing inefficiency.

Further Discussions

• The lecture concluded by mentioning the move to discuss positive externalities in future sessions.