Externalities

Definition: An effect whereby those not directly involved in taking a decision are affected by actions of others

When you are the third part, you're just effected by the world around you, and not involved in the decision.

Ex: Teacher learns a student to be very good in philosophy, that gets other people the student associate with, to think in a more philosophic way. Ergo: you are affected by what the student learnt from the teacher.

Costs and benefits

• Private- costs and benefits: Individuals directly involved in the decision to take a particular action, eighter as producers or consumers. The cost is incurred by when the individuals are taking a action. The benefits coming to the individuals who takes a particular action. Ex: A good/service payd by an individual.

• External- costs and benefits: consequences that falls on the third part. The costs are the consequences that happen to the third part. The benefits are the externalities to the third part. Ex: Noise problems.

• Social- cost and benefits: The total costs and benefits of a particular action.

Negative externalities

Definition: This exist where the social cost of an activity is reater than the private cost.

Examples:

• Illegal dumping of waste: The private cost to dumping is minimal. The external cost has to be covered by those such as local councils, responsible for maintaining the environment.

• Drinking: The private cost is the cost of what you drink and how sick you get. The external cost is the police who have to stand guard for you, and the the companyes which is cleaning the streets.

The problem with positive externalities is that there is under-production of Q and Q1, with too few scarce resources are being used. Therefore the market has hailed.

Positive externalities

Definition: This exist where the social benefit of an activity exceeds the private benefit.

Examples:

• Education and training: The private benefits is that you get improved skills, and get a better payd and more intressting job. The external benefits are that you get better qualified emplyees for firms, and in a long term, cmpetitiveness for the economy for the country.

• Crossrail: The private benefit is that everything is going to go faster. The external benefit is that the project will reduce road traffic, reducing overcrowding.

The problem with negative externalities is that there is overproduction of Q and Q1, and the price paid is lower than it should be. Therefore, the market has failed because of allocative inefficiency.