Externalities

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Externalities Key Definitons

  • External cost: cost that is associated with an economic transaction that is borne by a third party
  • Marginal social cost: the cost to society of producing an extra unit of a good
  • Marginal social benefit: the additional benefit that society gains from consuming an extra unit of good
  • Welfare loss: a representation of the loss to society, based on allocative inefficiency
  • Market failure: a situation in which the free market mechanism does not lead to an optimal allocation of scarce resources. The market is operating in an inefficient manner
  • Negative externality: a cost that is external to the market transaction and is thus not reflected in market prices. There is a divergence be seen MPC and MSC
  • Production externality: an externality that affects the production side of a market, which may be either positive or negative
  • Private cost - a cost incurred by an individual (firm or consumer) as part of its production or other economic transactions
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Merit and De-Merit Goods

Merit goods: are goods that bring unanticipated benefits to consumers, such that society believes they will be under consumed. The cause of this tends to be due to a lack of information, merit goods can be represented by the positive and negative consumption externality diagrams

De-merit goods: are goods that bring less benefits to consumers than they expect, it is over consumed in the free market. The cause of this tends to be due to a lack of information, de-merit goods can be represented by the positive and negative consumption externality diagrams

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