Compare and distinguish between positive and negative externalities. [8 marks]

Chapter: Market Failures

There are four causes for Market Failures, such as the existence of positive and negative externalities. Learn more about the characteristics and consequences of externalities on the economy. In the absence of government intervention, externalities would give rise to deadweight loss, which is a form of welfare loss to the society.

   07 August 2018

economics tuition notes definition

Externalities are the effects produced by individuals as a result of production or consumption of goods and services affecting the third party who are not involved in the production or consumption. These effects can be divided into positive and negative externalities. While positive externalities have beneficial effects that enhance the interest of the society such as community immunization from mass inoculation, negative externalities have harmful effects that are detrimental to the society, such as pollution occurred in the course of production. These two forms of externalities are similar and different in many ways.

Both forms of externalities will affect the value of cost and benefit calculation. Positive externalities will contribute to external benefit, which means that the social marginal benefit will be higher than the private marginal, As for negative externalities, it will incur external cost, which raises the social marginal cost as it adds onto the private marginal cost.

As a result in the increase in social and marginal cost and benefit, both forms of externalities will re-define the social optimal level of production or consumption, where the society will maximize its welfare gain. Without the presence of externalities, the society will produce at the level of production where PMC = SMB (private marginal cost = social marginal benefit) or PMB = SMC (private marginal benefit = social marginal cost). However, with externalities, the social optimal level of production will be at SMC’ (PMC + EMC) = SMB’ (PMB + EMB).

This also implies that externalities will disable the society to optimise its welfare. In the case of positive externalities, the society will be producing below its optimal level of output. AS for negative externalities, it will be producing above social optimal level of production. Nonetheless, both forms of externalities will cause the society to incur deadweight loss (DWL) if externalities are not taken into consideration. For positive externalities, DWL will be seen in term of the external benefit the society fails to reap and for negative externalities, DWL will be seen in term of the external cost the society needs to pay.

In conclusion, it can be seen the manner of the effects of both forms of externalities may differ but the economic effects on the society are quite the same. This will imply that approaches used to rectify them may differ so as to ensure that its detrimental effects are effectively eliminated.