Negative Externalities

Negative Externalities

A negative externality is when the consumption of a good has a negative effect or external cost on society. This is considered a market failure because the cost to society is not equal to the benefit to society. Example: Cigarettes

• Marginal (Private) Cost - cost for the firm making the product (cigarette company). It is represented by the supply curve.
• Marginal External Cost (or pollution cost) - cost to the environment and other members of society (people inhaling second hand smoke)
• Marginal Social Cost - the full cost to society
• Private Value or Benefit - this the benefit to the consumer from consuming the product. It is represented by the demand curve.

• The total surplus is the consumer surplus plus the producer surplus.
• The consumer surplus is the area above the price but below the demand.
• Normally, producer surplus is the area below the price but above the supply. However, when there's externalities, to find the producer surplus we use the following formula:

Private Equilibrium Socially Optimal Quantity (Allocative Efficiency)

Consumer Surplus ________ ________

Amount Received by Producers ________ ________

Social Cost to Society ________ ________

Producer Surplus ________ ________

Total Surplus ________ ________

• Benefit by moving to socially optimal quantity = ________
• Negative externalities are ________produced and ________priced at the private equilibrium.