Handout on Externalities - Dept of Economics University of Iowa Fall 2010 Professor Sarah Frank Externalities Negative Externalities If the consumption

1 Dept of Economics Fall 2010 University of Iowa Professor Sarah Frank Externalities Negative Externalities If the consumption or production of a good has a negative externality, it means there is a cost imposed on people who are neither the producers nor the consumers of the good. There is a cost that is external to the market; it is imposed on people outside the market transaction. Let’s consider the market for pesticides. Consumers who buy pesticides benefit from fewer insects growing on their plants. However, if children accidentally ingest the pesticide, they are at risk of getting sick. To see this graphically, we can draw the usual supply and demand curve for the market. But now, we give the demand curve a new name. We will call it the Marginal Private Benefit (MPB) curve. This is because the demand curve tells us the extra benefit received from an extra unit of the good. Moreover, it is the marginal PRIVATE benefit because it is the marginal benefit the consumers receive. We also rename the supply curve the Marginal Private Cost (MPC) curve. This is because the supply curve is merely the sum of all the individual firms’ marginal cost curves. But since it is the costs to the firms, it is a private cost.