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Externalities (Define (MPB (Marginal private benefits = Additional benefit…
Externalities
Define
Positive or negative effect (benefit v cost) to third parties who are not involved in the transaction; the market fails to achieve allocative efficiency as MSB ≠ MSC
Allocative efficiency is achieved when MSB = MSC
MPB
Marginal private benefits = Additional benefit to consumer derived from the consumption of an additional unit
MSB
Marginal social benefits = Additional benefits to society derived from the consumption of an additional unit
MSC
Marginal social costs = Additional costs to society derived from the consumption of an additional unit
MPC
Marginal private costs = Additional cost to consumer derived from the consumption of an additional unit
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Goods
Merit
Goods whose consumption creates positive consumption externalities; are socially desirable but underprovided by the market and underconsumed
These would thus, require government intervention to increase production and consumption = subsidies or provide free
Education, health care, infrastructure (roads, sewage...)
Demerit
Goods whose consumption creates negative externalities of consumption; are socially undesirable but are overprovided by the market and overconsumed
These would thus, require government intervention to reduce their production and consumption = taxation etc.
Cigarettes, alcohol, gasoline (fuel for cars)...
Public
A good that is non-rivalrous (its use by one does not make it less available for others) and non-excludable (Not possible to charge a price and exclude people from using it)
The free-rider problem: Occurs when people use a good without paying for it. People take a 'free ride' do not need to pay for it. Related to non-excludability
Due to there not being a price on the good, it is not profitable = firms do not want to produce it even if it is socially desirable.
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Government intervention
As public goods are socially desirable they are directly provided and finances by the government tax revenues
Of course, there is an opportunity cost on the spending hence, governments face difficulties of deciding what goods to invest in (park benches, street lamps, light house etc.)
Private
A good that is rivalrous (its use by one makes it less available for use by others) and excludable (people can be excluded).
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