I'm an economics student with too much going on in my head; this will be my e-whiteboard. Some things may be educational, some far from it - I apologise in advance. Yes I am on Twitter and no I don't bite, follow me: @Sam_Burrell. Gracias, peers, over and out.
Saturday, 13 April 2013
Externalities and Public Goods
Externalities are the effect on the third party of an action
made by an individual or a firm - whether it be for the better or the worse. A
lot of the time externalities are negative, pollution for example, and this is
the example we will use here. We'll look at a firm in industry creating a good
that means they are polluting the atmosphere.
With externalities being ignored, the firm will hire workers
and capital according to the rule: (Marginal revenue product of labour =
marginal cost of labour = wage = marginal cost of labour)
In Layman's terms, this means they'll employ labour up until
the point where the marginal revenue product of labour is equal to the marginal
cost of labour, meaning profits are being maximised. If the producer had to
clean up the pollution as well then the amount they'd employ would become:
What has been added is a new Price, the price of cleaning
pollution. This is taken away from the price of the product they're producing
which will overall leave a lower figure. If we rearranged above we could
The marginal cost of the good will now be the wage plus the
marginal cost of cleaning up the pollution. This means the social cost of the
firms actions have been taken into account. Previously, the marginal cost of
production was below the marginal social cost - leading to an overproduction.
Here it is graphically:
Q2 is the social optimum when the cost of clearing the pollution is taken into
account. If MSC is greater than MC then there are external costs of production,
if it's the other way round there are external benefits to production.
Now for a quick look at public goods, a fairly simple
sub-topic. A public good is one that has the characteristics 'non rival' and 'non
excludable'. What does this mean? It means that my consumption of the good does
not stop other people consuming it (non rival) and I cannot be prevented from
consuming the good once it is provided (non excludable). Street lighting is a
good example. It's a good that generally has to be provided by a government
because no individual or firm would pay for it - they'd just wait for someone
else to buy and free ride. A good that has only one of the characteristics
stated above but not both is known as a 'quasi-public good'.
That's all boys and girls! Comment if you need more help,
share the blog if it has assisted you. Cheers!