Externality Diagrams

POSITIVE
CONSUMPTION
EXTERNALITIES

In the case of a positive consumption externality, the social benefit of a good or service (MSB – Marginal Social Benefit) is greater than the private benefit (MPB – Marginal Private Benefit) experienced by the consumer. This means that the benefit to society as a whole is greater than the benefit to the individual consumer.

For example, when an individual purchases and uses an electric car, they benefit from lower fuel costs and a reduced carbon footprint. However, the wider community also benefits from reduced air pollution and a more sustainable environment. This positive impact on others is the externality.

In the diagram, the MSB curve is higher than the MPB curve, representing the fact that the social benefit is greater than the private benefit. We assume the marginal social cost (MSC) of producing the good or service is equal to the marginal private cost (MPC), which is shown by the MSC curve coinciding with the MPC curve.

In a market with a positive consumption externality, the market equilibrium (Qe) is below the socially optimal level of consumption (Qo) because the private consumer only takes into account their own benefit and not the positive impact on society. This leads to a potential welfare gain (shaded area in the diagram) which represents the loss of social welfare due to the under-consumption of the good or service.

NEGATIVE CONSUMPTION EXTERNALITIES

In the case of a negative consumption externality, the social benefit of a good or service (MSB – Marginal Social Benefit) is less than the private benefit (MPB – Marginal Private Benefit) experienced by the consumer. This means that the benefit to society as a whole is less than the benefit to the individual consumer. This means that their is cost to society as a whole.

For example, when an individual smokes cigarettes, they may experience pleasure or stress relief, but the wider community is negatively impacted by increased healthcare costs and reduced air quality. This negative impact on others is the externality.

In the diagram, the MSB curve is lower than the MPB curve, representing the fact that the social benefit is less than the private benefit. We assume the marginal social cost (MSB) of producing the good or service is equal to the marginal private cost (MPC), which is shown by the MSC curve coinciding with the MPC curve.

In a market with a negative consumption externality, the market equilibrium (Qe) is above the socially optimal level of consumption (Qo) because the private consumer only takes into account their own benefit and not the negative impact on society. This leads to a deadweight loss (shaded area in the diagram) which represents the loss of social welfare due to the over-consumption of the good or service.

POSITIVE
PRODUCTION
EXTERNALITIES

In the case of a positive production externality, the social cost of producing a good or service (MSC – Marginal Social Cost) is less than the private cost (MPC – Marginal Private Cost) experienced by the producer. This means that the cost to society as a whole is less than the cost to the individual producer.

For example, when a farmer grows crops using sustainable farming methods, they benefit from increased crop yield and profitability. However, the wider community also benefits from improved soil quality, reduced water pollution, and a more sustainable environment. This positive impact on others is the externality.

In the diagram, the MSC curve is lower than the MPC curve, representing the fact that the social cost is less than the private cost. We assume the marginal social benefit (MSB) of consuming the good or service is equal to the marginal private benefit (MPB), which is shown by the MSB curve coinciding with the MPB curve.

In a market with a positive production externality, the market equilibrium (Qe) is below the socially optimal level of production (Qo) because the private producer only takes into account their own benefit and not the positive impact on society. This leads to a deadweight loss (shaded area in the diagram) which represents the loss of social welfare due to the under-production of the good or service.

NEGATIVE PRODUCTION EXTERNALITIES

In the case of a negative production externality, the social cost of producing a good or service (MSC – Marginal Social Cost) is greater than the private cost (MPC – Marginal Private Cost) experienced by the producer. This means that the cost to society as a whole is greater than the cost to the individual producer.

For example, when a factory emits pollutants into the air or water during production, the wider community is negatively impacted by increased healthcare costs, environmental damage, and reduced quality of life. This negative impact on others is the externality.

In the diagram, the MSC curve is higher than the MPC curve, representing the fact that the social cost is greater than the private cost. We assume the marginal social benefit (MSB) of consuming the good or service is equal to the marginal private benefit (MPB), which is shown by the MSB curve coinciding with the MPB curve.

In a market with a negative production externality, the market equilibrium (Qe) is above the socially optimal level of production (Qo) because the private producer only takes into account their own cost and not the negative impact on society. This leads to a deadweight loss (shaded area in the diagram) which represents the loss of social welfare due to the over-production of the good or service.