In the case of a positive production externality, the social cost of producing a good or service (MSC – Marginal Social Cost) is less than the private cost (MPC – Marginal Private Cost) experienced by the producer. This leads to a deadweight loss (shaded area in the diagram) which represents the loss of social welfare due to the over-consumption of the good or service. In a market with a negative consumption externality, the market equilibrium (Qe) is above the socially optimal level of consumption (Qo) because the private consumer only takes into account their own benefit and not the negative impact on society. We assume the marginal social cost (MSB) of producing the good or service is equal to the marginal private cost (MPC), which is shown by the MSC curve coinciding with the MPC curve. In the diagram, the MSB curve is lower than the MPB curve, representing the fact that the social benefit is less than the private benefit. This negative impact on others is the externality. This means that the benefit to society as a whole is less than the benefit to the individual consumer. This means that their is cost to society as a whole.įor example, when an individual smokes cigarettes, they may experience pleasure or stress relief, but the wider community is negatively impacted by increased healthcare costs and reduced air quality. I n the case of a negative consumption externality, the social benefit of a good or service (MSB – Marginal Social Benefit) is less than the private benefit (MPB – Marginal Private Benefit) experienced by the consumer. This leads to a potential welfare gain (shaded area in the diagram) which represents the loss of social welfare due to the under-consumption of the good or service. In a market with a positive consumption externality, the market equilibrium (Qe) is below the socially optimal level of consumption (Qo) because the private consumer only takes into account their own benefit and not the positive impact on society. We assume the marginal social cost (MSC) of producing the good or service is equal to the marginal private cost (MPC), which is shown by the MSC curve coinciding with the MPC curve. In the diagram, the MSB curve is higher than the MPB curve, representing the fact that the social benefit is greater than the private benefit. This positive impact on others is the externality. However, the wider community also benefits from reduced air pollution and a more sustainable environment. This means that the benefit to society as a whole is greater than the benefit to the individual consumer.įor example, when an individual purchases and uses an electric car, they benefit from lower fuel costs and a reduced carbon footprint. In the case of a positive consumption externality, the social benefit of a good or service (MSB – Marginal Social Benefit) is greater than the private benefit (MPB – Marginal Private Benefit) experienced by the consumer.
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