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Externalities

Externalities 

An externality is a cost/benefit of a transaction that accrues to a third party, and therefore is not accounted for by the price mechanism, as it operates between the consumer and producer, no anyone else. 

 An externality involves a difference between private costs and benefits and social costs and benefits. 

 Private cost - cost incurred by an individual as part of its production or other economic activities. Cost of labour, capital etc the firm incurs. 
Private benefit - the benefit incurred by an individual/firm directly involved in the transaction either as a buyer or seller.  
Social cost - MPC + external cost
Social benefit - MPB + external benefit 
External cost - cost associated with an individual's production or other economic activities which is borne by a third party and so is not reflected in market prices. 
External benefit - " " 
Marginal - the cost of producing the next unit of a good. 

 Four types: 

 Negative Production externalities (e.g. Pollution - greenhouse gas emissions, waste byproducts, noise, visual, etc.) 


The size of the externality is the gap between the MSC and MPC. As these lines are parallel, the externality is constant- it does not change as the price/quantity increases. 
There is no consumption externality here so D = MSB = MPB. 
In a free, unregulated market, external cost will not be taken into account, as firms base supply on the MPC, so equilibrium will be at (Q1,P1). This isn't an ideal outcome as there is a difference between the MPC and MSC here, which results in welfare, or deadweight loss. This where producing the next good has a greater social cost than social benefit, so society would be better off without its production. 
The optimum position of equilibrium would be at (Q*,P*), where MSC = MSB.

 Taxation

 Taxation helps reduce the welfare loss by shifting the MPC up towards the MSC. This reduces the amount of the externality and pushes equilibrium closer to or at the optimum position. This is because taxes increase a firm's cost of production, so supply shifts in. 

 The government would aim to place a tax that would be equal to the size of the externality, thus eliminating it by internalising it. But it is hard to quantify the size of some externalities, which creates difficulties, as the tax has to be precisely the size of the externality. Too low and there will still be welfare loss, too high and welfare loss will be created on the other side of the supply curve. 

 Additionally, if a good has an inelastic PED, taxation will not have as great an impact on the quantity demanded, and there will be a higher consumer incidence (which is rather unfair, as this is a negative production externality). 

  Positive Production externalities (e.g. painting your house a nice colour, having an aesthetic front yard, etc.)

 Negative Consumption externalities (e.g. passive smoking, drink driving - costs to NHS and others - traffic congestion) 

 Positive Consumption externalities (e.g. Perfume, education, vaccination)  


HS2 


 Costs (for Lower Thorpe Mandeville) 
- noise pollution 
- property values fall 
- less tourism/business as less people will drive to Birmingham and stop in Lower Thorpe Mandeville on route. 
- loss of natural life/green space (park bisected by railway) 
Benefits (for Birmingham)
- increased property values 
- Increased tourism which leads to economic growth 
- increased investment in Birmingham as it is better connected 
- More jobs created 
- Multiplier effect 
- Reduced congestion, more space as less cars. 

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