Negative Externalities

• Caused by de-merit goods that are overprovided in a free market. There is a lack of consumer information about the long-term effects. E.g, smoking has the externality of lung disease

Positive Externalities

• Caused by merit goods that are under provided in a free market. This is because consumers lack the knowledge of the benefits of consuming the good.

Private Cost - MPC
The private costs of production, for example, costs of raw materials
External Costs -
The costs on a third party, e.g pollution from production
Social Costs - MSC
Private costs + Social Costs

Private Benefit - MPB
The private benefits from consumption of a good
External Benefit -
The benefit on a third party, e.g healthier lives from vaccine programs
Social Benefit - MSB
Private Benefit + External Benefit

Buffer Stocks

• The government buys excess supply to maintain price when excess is produced and sells it when not enough is produced

Minimum Prices (above equilibrium)

• Increases Wages
• Make de-merit goods more expensive to reduce consumption

Nudges

• The government tries to influence demand directly, e.g cigarettes behind closed covers

Tax

• Used to discourage de-merit goods using price mechanism
• If demand is inelastic such as addiction, no change in demand

Subsidy

• Using price mechanism to encourage the production of merit goods
• Risk of opportunity cost to government