Many of the most important externalities in the economy are concerned with pollution and the environment. See the article environmental economics for more discussion of externalities and how they may be addressed in the context of environmental issues.
Table of contents |
2 Negative Externality 3 Externalities and property rights |
Externalities can be illistrated on a standard supply and demand diagram if the externality can be monetized. An extra supply or demand
curve is added. One of the curves is the private cost that consumers pay for a given quanity of the good (marginal or average private cost) and the other curve is the cost that society pays
for the good (the marginal or average social cost). Similarly there might be two curves for the demand or benefit
of the good.
This graphics shows a negative externality. The private cost is less than the public cost. If the consumers only take into account their
own private cost they will end up at price Pp and quantity Qp, instead
of the more efficient price Pe and quantity Qe. The result is
inefficient since at the quantity Qp the benefit (a.k.a. the demand)
is less than the societal cost, so society would be better off if the
goods between Qe and Qp had not been produced.
Ronald Coase argued that where property rights are clearly defined, individuals will organise trades so as to bring about an efficient outcome and eliminate externalities. This result is often known as the Coase Theorem.Supply and Demand
Negative Externality
Externalities and property rights