Externalities
- When third parties, who are uninvolved, are affected by the benefits and costs involved in producing or consuming a particular good.
- The cost of a externality is not normally reflected in the price of a good, which is the cause for market failure.
Positive Externalizes
- Positive effects experienced bythird parties that come from consuming or producing a good.
Examples
- Education, leading to innovations and work in beneficial fields
- Buying a vaccination before travelling, preventing spreading sickness
- Buying a gym membership, allows people to be fit and strong, therefore better laborers. Reduction in healthcare costs.
Negative Externalities
- Negative effects experienced by third parties that come from consuming or producing a good.
Examples
- Waste of paint production dumped in a river, leading to environmental pollution.
- Smoking cigarettes, pollution, healthcare costs, second-hand smoking.
- Flying for a city trip, pollution, using airport space.
Merit Goods
- Goods that are beneficial to consumers and society as a whole and are usually under-provided.
Example
- Vaccines and gyms.
- When you use vaccines, they improve your health. However, there are additional benefits to society. As you are less likely to get sick, you can work more efficiently and consistently and don't risk spreading illnesses to others.
Demerit Goods
- Goods that are harmful to consumers and society as a whole and are usually over- provided.
Example
Cigarettes, alcohol, gambling.
When you use cigarettes, the nicotine gives you with a calming sensation that provides utility. However, there are additional costs not only to you, but to society as a whole. Smoking and second-hand smoking can worsen your and other people's health and increase the risk of illness. Then there is cost of equipment and labor to treat you if you get lung diseases for example.
Four Types of Externalities
Negative Externalities of Production
MSC > MPC
- The social cost of production is more than the private cost of production.
- The production process of a good or service generates a negative effect on a third party or on society as a whole.
- Private firms do not take the additional costs on society into consideration during production.
- There is over-production.
- For example toxic chemicals caused by the production of paint.
Positive Externalities of Production
- MSC < MPC
- The social cost of production is less than the private cost of production.
- There is underproduction.
- For example hospitals and healthcare services that improve health conditions.
Negative Externalities on Consumption
- MPB > MSB
- The social benefit of consuming a product is less than the private benefit of consuming the product.
- There is over-consumption.
- For example plastic bags which lead to pollution.
Positive Externalities of Consumption
- MPB < MSB
- The social benefit of consuming the product is more than the private benefit of consuming the product.
- There is under-consumption.
- For example using public transport leads to reduced emissions and less traffic.