Externality

… a core concept in Economic Analysis and Atlas102

Click for MRU video

Click for MRU video

Concept description

The Economist (reference below) defines externality as an economic side-effect – a cost or benefit arising from an activity and not reflected fully in prices.

Alex Tabarrok (reference below, video on right) uses the term bystanders in the following distinctions:

  • Private Cost – the cost paid by the consumer or the producer
  • External Cost – a cost paid by bystanders, by people other than the consumer or producer
  • Social Cost – the cost to everyone: the private cost + external cost
Click for MRU video

Click for MRU video

One can make analogous distinctions on the benefits side, and this is the subject of another Tabarrok video (reference below, video on right):

  • Private Benefit – the benefit received by the consumer or the producer
  • External Benefit – a benefit received by bystanders, by people other than the consumer or producer
  • Social Value (or social benefit) – the benefit to everyone: the private benefit + external benefit
External costs and the Pigouvian tax

Tabarrok uses the example of the external costs associated with overuse of antibiotics to show why the Efficient Equilibrium would have a different quantity and price than the Market Equilibrium, with a resultant Deadweight Loss.

ExernalCosts

One way to move the price and quantity to the efficient equilibrium is to impose a Pigouvian Tax, equal to the external cost, which makes the private cost plus tax equal to the social cost.

PigouvianTax2External benefits and the Pigouvian subsidy

Tabarrok uses the example of the external benefits associated with flu shots to show why the Efficient Equilibrium would have a different quantity and price than the Market Equilibrium, with a resultant Deadweight Loss.

ExternalBenefitsOne way to move the price and quantity to the efficient equilibrium is to introduce a Pigouvian Subsidy, equal to the external benefit, which makes the private benefit plus subsidy equal to the social value.

PigouvianSubsidy

Practice questions

From http://www.mruniversity.com/node/210427 and http://www.mruniversity.com/node/210518, accessed 6 May 2016.

  1. The price you pay for an iTunes download

Atlas topic, subject, and course

Externalities (core topic) in Economic Analysis and Atlas102 Economic Analysis.

Source

The Economist, Externality, Economics A-Z, at http://www.economist.com/economics-a-to-z/e#node-21529743, accessed 6 May 2016.

Alex Tabarrok, An Introduction to Externalities (12-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/externalities-definition-pigovian-tax, accessed 6 May 2016.

Alex Tabarrok, External Benefits (7-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/flu-shot-positive-externalities-pigovian-subsidy, accessed 6 May 2016.

Page created by: Ian Clark, last modified 6 May 2016.

Image: Alex Tabarrok, minute 0.14 of An Introduction to Externalities (12-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/externalities-definition-pigovian-tax, accessed 6 May 2016.