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MarketFailureand
GovernmentInterventionLesson2
ExternalitiesExternality:aneffectwherebythosenotdirectlyinvolvedintakingadecisionareaffectedbytheactionofother.(spillovereffect)
ExamplesResidentlivingalongtheflightpathtoanairport----numberofflightsincreasesoranadditionalrunwayopened.Fishmanfishinariver----chemicalfactorynearbydischargeswasteintotheriver,killingfishstocks.Governmenthavenewpolicytobanindoorsmoking----smokerssmokelesscigarettes.
ThirdPartyThirdparty:thosenotdirectlyinvolvedinmakingadecision.Anexternalityissocalledbecauseitisanactionthathasaneffectonathirdparty.
Costsandbenefits3typesofcostsandbenefits-privatecostandprivatebenefit-externalcostsandexternalbenefit-socialcostandsocialbenefit
PrivatecostandbenefitPrivatecosts:thecostincurredbythosetakingaparticularaction.Privatebenefits:thebenefitsdirectlyaccruingtothosetakingaparticularaction.
ExternalcostsandbenefitsExternalcosts:thecoststhatareconsequenceofexternalitiestothirdparties.Externalbenefits:thebenefitsthataccrueasaconsequenceofexternalitiestothirdparty.
SocialcostsandbenefitsSocialcosts:thetotalcostsofaparticularaction.Socialbenefit:thetotalbenefitsofaparticularaction.
EconomicproblemarisesWhentheprivatecostsorprivatebenefitsdonotexactlyequalthesocialcostorsocialbenefit.
NegativeexternalitiesNegativeexternality:thisexistswherethesocialcostofanactivityisgreaterthantheprivatecost.(therearecostsimposedonathirdpartyoverandabovethecostsdirectlypaidforbythosewhocarryouttheactivity)
DiagramNegativeexternalitiescreateexternalcost-ifthemarketdoesnottakeexternalitiesintoaccounttheresultisthatthesociallyefficientoutputislessthancurrentoutput.
ExternalCostsPriceQuantityBoughtandSoldMSBMPC£5100MSC=MPC+ExternalCost£12SocialCostVa
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