When we talk about a company that is throwing their wastes into the river - polluting the area - because it is cheaper for them and as a consequence their total costs can be reduced, we are dealing with an example of an externality.
When we see a person that smokes inside a closed room, we are dealing with an externality too.
When someone decides to get a vaccine, yes, again an externality appears.
So, what are externalities then?
A definition can say that are decisions that would be affecting a third party that was not involved in the decision making. They can produce a positive or a negative effect over that party.
In the first case we have that the action taken by the company will be related with a negative externality of production. The solution to that problem will be that the firm will have to take care of the damage they are producing.
When we see a person that smokes inside a closed room, we are dealing with an externality too.
When someone decides to get a vaccine, yes, again an externality appears.
So, what are externalities then?
A definition can say that are decisions that would be affecting a third party that was not involved in the decision making. They can produce a positive or a negative effect over that party.
In the first case we have that the action taken by the company will be related with a negative externality of production. The solution to that problem will be that the firm will have to take care of the damage they are producing.
As a consequence their total costs (Marginal Private Cost) will probably be increased, followed by an inward shift of the supply curve (reaching now the Marginal Social Cost).
In the second example, the smoker affects other people inside the room (passive smokers) in a bad way. So The Marginal Private Benefit (directly related with the smoker) will be higher than the Marginal Social Benefit (the effect over the other persons).
By the way, the market will be in equilibrium when the Marginal Social Benefit is equal to the Marginal Social Cost.
M.S.B. = M.S.C.
Till my next post!
Prof. Fernando Julio Silva, MSc.
APRIL 2009
In the second example, the smoker affects other people inside the room (passive smokers) in a bad way. So The Marginal Private Benefit (directly related with the smoker) will be higher than the Marginal Social Benefit (the effect over the other persons).
By the way, the market will be in equilibrium when the Marginal Social Benefit is equal to the Marginal Social Cost.
M.S.B. = M.S.C.
Till my next post!
Prof. Fernando Julio Silva, MSc.
APRIL 2009
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