Externalities

ExternalitiesExternalities

Externalities in production(a) external costs

Externalities in production(a) external costs

Q1O

MC = S

DP

Co

sts

and

be

nef

its

Quantity

External costs in productionExternal costs in production

O

MC = S

DP

MSC

Co

sts

and

be

nef

its

Quantity

External cost

Q1Q2

Social optimum

External costs in productionExternal costs in production

ExternalitiesExternalities

Externalities in production(b) external benefits

Externalities in production(b) external benefits

O

DP

MC = S

Q1

Co

sts

and

be

nef

its

Quantity

External benefits in productionExternal benefits in production

O

MSC

DP

Q1

External benefit

Co

sts

and

be

nef

its

Quantity

MC = S

Q2Social optimum

External benefits in productionExternal benefits in production

O

MC = S

DP

Q1Q2

Cos

ts a

nd b

enef

its (

£)

Quantity

MSC

External cost

(a ) External costs

O

DP

Q2Q1

Cos

ts a

nd b

enef

its (

£)

Quantity

MSCMC = S

External benefit

(b) External benefits

External costs and benefits in production

ExternalitiesExternalities

Externalities in consumption(a) external costs

Externalities in consumption(a) external costs

Q1

(MB)MU = D

O

DP

Co

sts

and

be

nef

its

Quantity

External costs in consumptionExternal costs in consumption

Q2

(MB)MU = D

O

DP

Co

sts

and

be

nef

its

Quantity

External cost

MSB

Q1

External costs in consumptionExternal costs in consumption

Social optimum

ExternalitiesExternalities

Externalities in consumption(b) external benefits

Externalities in consumption(b) external benefits

(MB)MU = D

O

DP

Q1

Co

sts

and

be

nef

its

Quantity

External benefits in consumptionExternal benefits in consumption

Q2

(MB)MU = D

O

DP

Q1

Co

sts

and

be

nef

its

Quantity

External benefit

MSB

External benefits in consumptionExternal benefits in consumption

Social optimum

O

MB

PP

Cos

ts a

nd b

enef

its (

£)

Car miles

MSB

External cost

O

MB

PP

Q1

Cos

ts a

nd b

enef

its (

£)

Rail miles

Q2

MSB

External benefit

(a ) External costs (b) External benefits

External costs and benefits in consumption

Q1Q2

ExternalitiesExternalities

Using taxes to correct for an externality(a) external cost in production

Using taxes to correct for an externality(a) external cost in production

Q1O

MC = S

DP

Co

sts

and

be

nef

its

Quantity

Using taxes to correct a market distortionUsing taxes to correct a market distortion

O

MC = S

DP

MSC

Co

sts

and

be

nef

its

Quantity

External cost

Q1Q2

Social optimum

Using taxes to correct a market distortionUsing taxes to correct a market distortion

Q2

MC

Q1O

DP

Co

sts

and

be

nef

its

Quantity

Optimum tax = MSC – MC

MC = SMSC

Using taxes to correct a market distortionUsing taxes to correct a market distortion

Amount of tax

Q2

MC

Q1O

DP

Co

sts

and

be

nef

its

Quantity

MC = SMSC

Using taxes to correct a market distortionUsing taxes to correct a market distortion

ExternalitiesExternalities

Using subsidies to correct for an externality(a) external benefits in production

Using subsidies to correct for an externality(a) external benefits in production

O

DP

MC = S

Q1

Co

sts

and

be

nef

its

Quantity

Using subsidies to correct a market distortionUsing subsidies to correct a market distortion

O

MSC

DP

Q1

External benefit

Co

sts

and

be

nef

its

Quantity

MC = S

Q2Social optimum

Using subsidies to correct a market distortionUsing subsidies to correct a market distortion

MC

O

P

Q2Q1

Co

sts

and

be

nef

its

Quantity

Optimum subsidy

= MC – MSC

MSCMC = S

D

Using subsidies to correct a market distortionUsing subsidies to correct a market distortion

Amount ofsubsidy

MC

O

P

Q2Q1

Co

sts

and

be

nef

its

Quantity

MSCMC = S

D

Using subsidies to correct a market distortionUsing subsidies to correct a market distortion