Types of Externality Externality can be production or consumption depending on whether the externality is caused by production or consumption activities.Examples of production externality: A paper factory dumping its waste to the river. Example of consumption externality:Cigarette smoking in the classroom, Drinking and driving. 6
Consider a paper factory that pollutes the environment during its production process. The marginal cost of the factory’s production = MC (denoted as MCPin the text). In the production process it emits pollution that harms the environment, the marginal external cost caused by each extra pollution = MEC (denoted as MCgin the text). Then the total marginal cost of production including the external cost, marginal social cost, MSC (denoted as MCsin the text) = MC + MEC. Inefficiency of Competition with Externality 7
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