Lecture 3 - Lecture 3 Externalities Externalities When the...

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Lecture 3 Externalities
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Externalities When the activity of one entity directly affects of welfare of another in a way that is outside the market mechanism Can be positive or negative One action can have multiple externalities Classic example of market failure Government intervention allows for the opportunity to assign responsibility for the externalities
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Negative Production Externality A firm’s production reduces the well- being of others who are not compensated by the firm Private MC ≠ Social MC Social MC = Private MC + Marginal Damage
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Negative Consumption Externality An individual’s consumption reduces the well being of others who are not compensated by the individual Private MB ≠ Social MB Social MB = Private MB – Marginal Damage
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Positive Externalities When a firm’s production increases the well-being of others but the firm is not compensated by those others Private MC ≠ Social MC Underproduction in private case relative to best social case
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Consider: Market for SUVs
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