Externalities and social costs and benefits
Private, external and social
- a private cost/benefit falls on the buyer or seller.
- an external cost/benefit falls on a third party.
- social cost = private + external cost; social benefit = private + external benefit.
Practice
Social cost is equal to:
Social cost = private cost + external cost (the same structure applies to benefits).
Marginal analysis
- Best for society: where MSC = MSB. The market produces where MPC = MPB.
- negative externality (pollution): MSC above MPC → market makes too much.
- positive externality (education): MSB above MPB → market makes too little.
- The lost welfare from this gap is the deadweight welfare loss.
Practice
The socially optimal output is where:
Society's best is MSC = MSB; the market produces at MPC = MPB, creating a welfare gap.
Practice
The lost welfare from over- or under-production caused by an externality is the deadweight welfare loss.
The triangle between the social and private curves is the deadweight welfare loss.
You've got it
Key idea
- social cost = private + external cost (same for benefit)
- society's best is MSC = MSB; the market gives MPC = MPB
- negative externality → over-production; positive → under-production; the gap = deadweight loss