Negative Consumption

Externality
Unit 5 - Lesson 3

Learning outcomes:
Explain using diagrams and examples, the
concept of negative consumption
externalities and the welfare loss associated
with the production of the good.
Evaluate using diagrams the use of
government policies and regulations to
correct the externality.

Negative Production Externality

Allocatively inefficient market not producing at the
socially optimum amount.
The consumption of a good or service creates a
spillover cost to a 3rd party (society)
The free market over allocates resources to the
production of the good.
MPB (Marginal Private Benefit) > MSB (Marginal
Social Benefit)

Examples:

Smoking
Alcohol consumption
Gambling
Automobile use

What spillover costs are associate with the

consumption of the above examples?

Negative Consumption Externality

Alcohol Consumption:
S = MSC = MPC
MSC/MPC = MPB (Marginal Private
Benefit) - point B - free market
allocation of alcohol.
Allocatively (socially) efficient amount
MSC/MPC = MSB point A
Over allocation of resources to the
production of the good. Q(free
market) > Q1(socially efficient)

Negative Consumption Externality

Due to the market being allocatively
inefficient a Welfare Loss occurs
represented by the red triangle A - B C.
The vertical distance between the
MPB & MSB is equal to the spillover
cost.
What type of spillover costs occur
with alcohol consumption?

Solutions:
In order to correct the Market
Failure, the market must
produce at the Socially Optimum
output.
Two ways:
1. Move MPB toward MSB
2. Decrease MPC
Solutions include: Legislation & Regulation
Taxes
Advertising & persuasion

Legislation & Regulation & Taxes

By placing regulations and/or taxes
on firms this in turn decreases the
MSC shifting it left.
Goal is to decrease the output of the
firm such that it produces at the
socially efficient amount.
Both Government Intervention
measure have the effect of
increasing the cost of production for
firms.

Examples of Legislation & Regulations

Have you seen any of
these signs?

Advertising & Persuasion

Advertising & Persuasion is a
determinant of Demand = MPB.
Aim is to decrease D=MPB shifting it
left and moving it closed to the MSB
thus reducing the size of the welfare
loss.
By decreasing the MPB toward MSB
the market moves closer to producing
the Socially Efficient Quantity
represented by Q*

Examples of Advertising & Persuasion

Have you seen these signs?