EXTERNALITIESJess Martin

Sophie McGrathHayley McCluskie

Niamh McLean

What is an externality?

An externality is the external effects associated with the production and consumption of goods and services.

This can be further classified as positive or negative.

Positive externalities

A positive externality is the benefit that is enjoyed by a third party as a result of an

economic transaction. (Economics online)

Third parties can include any individual, company, property owner or resource that is

indirectly effected.

Positive externalities diagramThis diagram highlights what

happens in order for a positive externality to arise.

P1, Q1 represent the private benefit. (demand is equal to supply)

This would be the benefits received by the individual or organisation providing the product or service.

However as a positive externality relates to the benefits society

receives, Q2 is where the social cost is equal to the social benefit.D=PMB (this stands for the demand, the private benefit)

SMB (stands for the social benefit)S=PMC=SMC (stands for supply is equal to the private cost which is equal to the social cost)

Example 1: Small pox vaccination Before 1958 many people faced the threat of contracting small pox.

Small pox is a highly infectious and often lethal disease. Some of the symptoms include:

• High fever• Aches and pains

• The eruption of pimples that later blister and cause what is known as pockmarks.

Because of the lack of vaccinations this meant that almost anyone was at risk of contracting the disease and so the potential for the disease to become

widespread was great.

If the disease was to become widespread then this would cause many fatalities and as a result the population would be significantly effected.

Small pox: what happened?

In order to stop the disease becoming widespread, a vaccination was introduced and sponsored by the world health organization (WHO).

The WHO are a large organisation who are concerned with the protection and well being of the global population. Therefore their

interest in this case was to ensure that the disease was controlled and not passed on. The main aim was to control the disease through the

vaccination programme.

The vaccination programme was successful as in 1977 small pox disappeared entirely and now no one will die of this disease again.

Why is the smallpox vaccination a positive externality?

A positive externality is defined as the benefit enjoyed by a third party as a result of an economic transaction.

In this case the economic transaction was the vaccination programme that was introduced. The aim of the vaccination was to control the spread of the

disease.

The benefit that was, and still is enjoyed by the economy as a whole is that the disease has been eradicated and now has disappeared entirely.

Now no one will ever die of this disease again as there is a vaccination to help stop individuals contracting any further symptoms.

Negative externalities

Externalities are third party effects arising from production and consumption of goods and

services for which no appropriate compensation is paid. (Economics online)

Negative externality diagram

This diagram highlights what happens in order for a negative

externality to arise.

P1, Q1 represent the private marginal benefit. (demand is equal

to supply)

SMC (stands for Social Marginal Cost)S = PMC (stands for Supply = Private Marginal Cost)D = PMB (stands for Demand = Marginal Private Benefit)

Welfare loss

Example: Smoking

Smoking is the cause of death of 1 in 5 people in the US.

Smoking also includes passive smoking which not only affects the smoker but also the people surrounding them.

A single cigarette contains over 4,800 chemicals which 69 of these are known to cause cancer.

Smoking increases your risk of getting lung diseases like pneumonia, emphysema and chronic bronchitis.

Smoking: What is taking place?In 2007 legal restrictions on smoking in workplaces and public places were

introduced across England, Wales and Northern Ireland.

Regulations relating to smoking in company vehicles came into force on 1 July 2007.

Smoking is not allowed in any enclosed workplace, public building or on public transport in the UK the penalty can be up to £200.

The legal minimum age to purchase cigarettes in the UK has risen from 16 to 18.

Why is smoking a negative externality?

Smoking causes damage not only to the person whom wishes to smoke but also to the people around them who breathe in their smoke, this is a negative

externality as people whom wish to smoke are not only damaging them selves but also forcing the people around them to smoke (also known as

passive smoking).

Smokers ignore the harmful impact of toxic ‘passive smoking’ on non-smokers.

Since the smoking ban the emission to hospital of children with asthma has dropped by 8% this shows that the smoking ban is decreasing the negative

externality of smoking.