Externalities

[Fermat]

Hey guys, I'm studying for a economics test on externalities and I have some trouble understand the graphs. For example:

If I want to look the externalities of smoking ciggarettes. So on my graph, S = MSC and D = MPB. Smoking is a negative externality because it affects people around you in a negative way. So now I know that the new curve will be to the left of either S or D.I thought that the new curve should be to the left of the demand curve because the marginal social benefit is lower that the marginal private benefit. But this is apparently wrong.

My book is calling the "initial" supply curve for S = MPC (marginal private cost) and then the new supply curve is S = MSC (marginal social cost) and I understand why that is, because the social costs are higher than the private costs. What I don't get is how you tell where the new curve will be. Because if the new curve is to the left of S or D, it shows a negative externality but how do you know what curve you should pick?

I know that I'm not explaining this very well but if you have any ideas on what I'm talking about I'd really appreciate the help!

EDIT: Does it have anything to do with if it is an externality caused by production or consumption? So like if it's an externality caused by production, there will be a new supply curve and when the externality is caused by consumption, there will be a new demand curve?

Edited October 21, 2012 by Fermat

[IB Failing]

As smoking would be regarded as a negative consumption externality (due to the effect on third-parties via consumption, not production - textbooks usually use pollution emitted from production of X as a negative production externality), you'd be correct in stating that the MSB curve is to the left of the demand curve (MPB).

Your book might be referring to a negative production externality at this point, as a negative consumption externality (like cigarette smoking) has S = MPC = MSC (social costs = private costs).

To determine where the 'new curve' would be, draw it so that if a negative externality is incurred, the quantity supplied is greater than social optimum (Q at which MSC = MSB). You're also right in saying that negative production externalities have MPC > MSC, thus the S curve shifts right and therefore quantity produced is greater than Q_opt, and negative consumption externalities have MPB > MSB in which the D curve has shifted right so quantity produced is also greater than Q_opt.

Sorry if I explained it badly, try reading this page on Tutor2U if you haven't already: http://www.tutor2u.n...ernalities.html

Edited October 21, 2012 by IB Failing

[Fermat]

Thanks you so much for the explanation and that link, it really cleared things up!

But just a quick question,you said that the S and D curves would shift to the right in the case of a negative externality, shouldn't that be to the left? I thought that a posetive externality would shift it to the right.

[IB Failing]

But just a quick question,you said that the S and D curves would shift to the right in the case of a negative externality, shouldn't that be to the left? I thought that a positive externality would shift it to the right.

Sorry, I don't even understand what I meant in that last paragraph . If correcting the externality, MPC/MPB would shift left, depending on the type. It helps to visualise it with a diagram though.

Using that example, D = MPB, and is to the right of MSB, hence Q is supplied (whereas Q* is socially optimum). Correcting the externality involves shifting the D curve (MPB) to the left so that MPB = MSB.

Negative production: S is too great, hence MPC > MSC - to correct, supply must be decreased, so MPC shifts left to MSC.

Negative consumption: D is too great, hence MPB > MSB - to correct, demand must be decreased, so MPB shifts left to MSB.

[Dimitris]

if it is a negative externality in either case (consumption externality or production externality) you draw a second curve to the left indicating MSC (if negative prod. externality, supply) or MSB (if neg. cons. externality, demand). in a positive externality you draw a second curve to the right indicticating again the curves respectively (MSC OR MSB).

Your initial question: you choose what curve based on the fact whether it is production or consumption (if production you manipulate supply, if consumption you manipulate demand)

hope it helped

[Fermat]

Thank you guys! I actually get it now

Just want to make sure that I'm 100% sure, so since producing steel causes pollution when producing the good it is a negative externality of production, thus the supply curve will shift to the left of the MPC.

And taking a flu vaccination is a benefit to society when you "consume" the vaccination so it's a positive externality of consumption, thus the demand curve will shift to the right of the MPB. Meaning MSB > MPB

It makes a lot more sense now, thanks again

[Dimitris]

thats right you got it

[alexhurt]

Hey guys just a quick question on negative externalities, we were looking at how Pakistan are looking to improve their state education and we have to draw diagrams before and after the subsidy and improvement is in effect. Before they introduce the subsidy would the poor education be a negatively externality of production or consumption ?

Thanks