Demand side externalities - FreeEconHelp.com, Learning Economics... Solved!

8/15/15

Demand side externalities

Externalities can be either positive or negative. They occur when a third party not directly involved in a transaction is affected by the transaction. For example, when someone decides to buy cigarettes and smoke them, they purchase the cigarettes from a firm (which incurs a cost and makes a profit) and then smokes them (enjoying the leisure associated with cigarette smoking). However, anyone near the smoker incurs the cost of having to breath/smell/see the smoke (which may be quite high if they are allergic). This cost to the third party occurs outside of the traditional supply and demand framework, which is why it is called an externality. Identification of the externality allows us to separate the private marginal benefit of an action vs. the social marginal benefit.



Looking at the graph, we should recognize SMB1 as the original demand curve that focuses on our end user. While SMB generally means social marginal benefit, we can think of it as private marginal benefit in the following example. When this consumer smokes a cigarette, they are imposing a cost to society (on others nearby) and this cost reduces the social marginal benefit associated with cigarette smoking. This is visualized by the SMB3 curve. We can see that the SMB3 curve crosses the supply curve at a lower price and quantity, which demonstrates that the social marginal benefit is smaller than the private marginal benefit. It also shows us that the equilibrium quantity (to maximize societal welfare) is smaller than the private equilibrium if we were to ignore the externality. One way to deal with a negative externality is through a tax. By taxing the individuals causing the negative externalities, they experience a higher private cost (or lower benefit) which will reduce their consumption.
Positive and negative demand externalities

However, it is also possible for there to be positive externalities. A common example of a positive externality is choosing to pay for education (if no comparable free options are available). Studies suggest that an educated population is good for society, so individuals choosing to become educated create a positive external effect on those in their community (imagine where we would be without doctors or researchers finding cures for things). This can be visualized in the graph by looking at the SMB2 curve. It shows that the social marginal benefit is higher than the private marginal benefit. This makes sense, because when one chooses to pay for school, they generally ignore the greater effects that their education can play on society. They choose to go based on their own perceived benefit from the decision. However, we can see on the graph that the SMB2 curve intersects the supply curve at a higher quantity and price than the private marginal benefit curve. This means that we are under producing/consuming education and that in order to maximize societal welfare, we should produce more or create a subsidy to encourage the optimal quantity.

35 comments:

  1. Anonymous15 May

    I do not know how to calculate P= 21-Q, MR = 21-2Q, TC = 3+Q+Q>2, MC = 1+2Q.

    ReplyDelete
  2. It is amazing and wonderful to visit your site.Thanks for sharing this information,this is useful to me...
    Android Training in Chennai
    Ios Training in Chennai

    ReplyDelete
  3. Candid institute Spring and Hibernate course provides a comprehensive introduction to Spring and Hibernate open source frameworks as well as Web Services and AJAX. Suitable for both Spring3/Hibernate3 and Spring4/Hibernate4, the course includes coverage of the core Spring and Hibernate capabilities, as well as the integration capabilities provided by Spring.
    spring hibernate training institutes in chennai

    ReplyDelete
  4. Pretty good post. I just stumbled upon your blog and wanted to say that I have really enjoyed reading your blog posts. Any way I'll be subscribing to your feed and I hope you post again soon. Big thanks for the useful info. You put really very helpful information. Keep it up. Keep blogging. Looking to reading your next post.
    Hadoop Training in Chennai
    Big Data Training in Chennai
    Python Training in Chennai
    Python Training Centers in Chennai
    Data Science Training in Chennai
    Data Science Course in Chennai
    Data Analytics Training in Chennai
    Best AngularJS Training in Chennai
    AngularJS Training in Chennai
    QlikView Training in Chennai
    Informatica Training in Chennai

    ReplyDelete
  5. Your good knowledge and kindness in playing with all the pieces were very useful. I don’t know what I would have done if I had not encountered such a step like this.
    Data Science Training in Hyderabad

    ReplyDelete
  6. I have read your article. it is very informative and helpful for me.I admire the valuable information you offer in your articles. Thanks for posting it, again!
    - driving directions

    ReplyDelete
  7. In the beginning, I would like to thank you much about this great post. Its very useful and helpful for anyone looking for tips. I like your writing style and I hope you will keep doing this good working.
    PHP Training in Chennai
    DOT NET Training in Chennai
    Big Data Training in Chennai
    Hadoop Training in Chennai
    Android Training in Chennai
    Selenium Training in Chennai
    Digital Marketing Course in Chennai
    JAVA Training in Chennai
    Selenium training institute in Chennai

    ReplyDelete
  8. Informative Blog, Thank you to share this
    Regards,
    PHP Training in Chennai | PHP Course in Chennai

    ReplyDelete
  9. The article is very interesting and very understood to be read, may be useful for the people. I wanted to thank you for this great read!! I definitely enjoyed every little bit of it. I have to bookmarked to check out new stuff on your post. Thanks for sharing the information keep updating, looking forward for more posts..
    Kindly visit us @
    Madurai Travels | Travels in Madurai
    Best Travels in Madurai
    Cabs in Madurai | Madurai Cabs
    Tours and Travels in Madurai

    ReplyDelete
  10. This comment has been removed by a blog administrator.

    ReplyDelete
  11. This comment has been removed by a blog administrator.

    ReplyDelete
  12. This comment has been removed by a blog administrator.

    ReplyDelete
  13. This comment has been removed by a blog administrator.

    ReplyDelete
  14. Thanks for Sharing This Article.It is very so much valuable content. I hope these Commenting lists will help to my website
    microservices online training

    ReplyDelete
  15. Great Article. Thank you for sharing! Really an awesome post for every one.

    IEEE Final Year projects Project Centers in Chennai are consistently sought after. Final Year Students Projects take a shot at them to improve their aptitudes, while specialists like the enjoyment in interfering with innovation. For experts, it's an alternate ball game through and through. Smaller than expected IEEE Final Year project centers ground for all fragments of CSE & IT engineers hoping to assemble. Final Year Project Domains for IT It gives you tips and rules that is progressively critical to consider while choosing any final year project point.

    JavaScript Training in Chennai

    JavaScript Training in Chennai


    ReplyDelete