Negative Externalities of Consumption

NEGATIVE EXTERNALITIES OF CONSUMPTION

• A negative externality of consumption is a cost suffered by a third party as a result of an economic transaction e.g. the  cost to society of people consuming alcohol[pic 1]

The consumption of alcohol negatively affects the public and the government. Any crime committed or health cost caused by the consumption of alcohol is considered a negative externality. In a standard supply and demand diagram, the benefit to the market of consuming a certain good at a certain price is considered to be the same as the benefit to the public (MPB=MSB). However due to the negative externality the MSB is less than the MPB.  This means the market is overproducing by Q-Q1 as all those units are generating negative welfare.

One way to reduce production from Q to Q1 is to impose an indirect tax on alcohol. This would increase the costs of production so supply shifts left moving the market equilibrium closer to the social equilibrium. In Scotland, to combat the overproduction of alcohol they are trying to introduce a minimum unit price.  If this price is above the market equilibrium, the minimum price would cause demand to contract, moving the market equilibrium towards the social equilibrium.

NEGATIVE EXTERNALITIES OF PRODUCTION

• A negative externality of production is a cost suffered by a third party as a result of an economic transaction e.g. the  cost to the public of people consuming alcohol[pic 2]

The production of goods almost always leads to the emission of pollution. Pollution negatively affects many third parties in many different ways. Visual and noise pollution affects the public and can reduce the value of goods e.g. house prices next to a factory. Also, pollution can cause many health effects which have a cost on the NHS. Pollution can lead to acid rain which then adversely affects the environment and this can lead to reduced tourism etc. These costs cause MSC to be greater than MPC so the market is overproducing by units Q to Q1.