![]() ![]() ![]() Our new objective considering all impacted agents in society is to maximize social surplus or total social benefits minus total social costs. When we were considering private markets, our objective was to maximize market surplus or total private benefits minus total private costs. When we add external costs to private costs, we create a marginal social cost curve. In the presence of a negative externality (with a constant marginal external cost), this curve lies above the supply curve at all quantities.In the presence of a positive externality (with a constant marginal external benefit), this curve lies above the demand curve at all quantities. When we add external benefits to private benefits, we create a marginal social benefit curve.External costs and benefits occur when producing or consuming a good or service imposes a cost/benefit upon a third party. When we account for external costs and benefits, the following definitions apply: To do so, we must consider the external costs and benefits. We now want to develop a model that accounts for positive and negative externalities. Our topic three supply curve is equivalent to the marginal private cost curve.Our topic three demand curve is equivalent to the marginal private benefit curve.The terms consumer surplus, producer surplus, market surplus, and the market equilibrium (note that this will be referred to interchangeably in this chapter as the unregulated market equilibrium) derive their meaning from an analysis of private markets and need to be adapted in a discussion where external costs or external benefits are present.įor the purpose of this analysis, the following terminology will be used: Thus, the terminology we used in that analysis applies to private markets. Enriching Our ModelĪs discussed earlier, we have previously modelled private markets. A positive externality occurs when the market interaction of others presents a benefit to non-market participants. The club imposed a cost on you, an external agent to the market interaction. The club example from above is that of a negative externality. Because externalities that occur in market transactions affect other parties beyond those involved, they are sometimes called spillovers.Externalities can be negative or positive. The effect of a market exchange on a third party who is outside or “external” to the exchange is called an externality. In this case, the club’s owners and attendees may both be quite satisfied with their voluntary exchange, but you have no voice in their market transaction. But what happens when a voluntary exchange affects a third party who is neither the buyer nor the seller?As an example, consider a club promoter who wants to build a night club right next to your apartment building. You and your neighbours will be able to hear the music in your apartments late into the night. The principle that voluntary exchange benefits both buyers and sellers is a fundamental building block of the economic way of thinking. Private markets only consider consumers, producers and the government – the impacts on external parties is irrelevant. The perfectly competitive market we modelled offered an efficient way to put buyers and sellers together and determine what goods are produced, how they are produced, and who gets them. Externalities To this point, we have modelled private markets. Before we get to this conclusion, let’s first unpack this concept of externalities. We will learn that the all-regulation-is-bad-regulation conclusion from earlier is not always the case – in many situations, we can improve societal outcomes with policy. We will find that the equilibrium that is optimal for consumers and producers of the good may be sub-optimal for society. We can now add the concept of Externalities to our supply and demand model to account for the impact of market interactions on external agents. Our assumption throughout this analysis, however, was that there was no third party impacted by the interaction of producers and consumers. quota, price control, tax, etc.) moved the market away from the surplus maximizing equilibrium and created a deadweight loss. We also demonstrated that any policy that was introduced (i.e. We observed how producers and consumers of a good interacted to reach equilibrium. In particular, we closely examined perfectly competitive markets. In Topics 3 and 4 we introduced the concept of a market. Identify equilibrium price and quantity.Explain and give examples of positive and negative externalities.By the end of this section, you will be able to: ![]()
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