Impact of Externalities on
Market
PRESENTED BY
Hamza Javed
Roll# 19010920-107
Ayesha Iftikhar
Roll# 19010920-074
Sarim Riaz
Roll# 19010920-108
Rizwana Liaqat
Roll# 19010920-073
Externalities and it Types
PRESENTED BY
HAMZA JAVED
ROLL# 19010920-107
What is Externalities?
An externality refers to the uncompensated impact of
one person’s action on the well being of a bystander.
Externalities cause markets to be inefficient, and thus
fail to maximize total surplus.
When externalities arises?
When a person engages in an activity that influences
the well being of a bystander and yet neither pays nor
receives any compensation for that effect.
Types of externality
When the impact on the bystander is adverse, the
externality is called a negative externality.
When the impact on the bystander is beneficial, the
externality is called a positive externality.
Negative Externalities
Figure 1
Figure 1
The Market for Aluminum
The demand curve reflects the value to buyers, and the supply
curve reflects the cost of sellers. The equilibrium quantity,
Q(market) maximizes the total value to buyers minus the total
cost of sellers. In the absence of externalities, therefore, the
market equilibrium is efficient.
Figure 2
Figure 2
Pollution and the social Optimum
In the presence of a negative externality, such as
pollution, the social cost of the goods exceeds the
private cost. The optimal quantity Q(optimum) is
therefore smaller than the equilibrium quantity,
Q(market).
Figure 3
Figure 3
Education and the Social optimum
In the presence of positive externality, the social value of the
good exceeds the private value. The optimal quantity,
Q(optimum) is therefore larger than the equilibrium quantity,
Q(market).
Figure 4
Figure 4
In panel (a), the EPA sets a price on pollution by leaving
a corrective tax, and the demand curve determines the
quantity of pollution. In panel (b), the EPA limits the
quantity of pollution by limiting the number of
pollution permits, and the demand curve determines
the price of pollution. The price and quantity of
pollution are the same in the two cases.
Questions?
POSITIVE EXTERNALITIES
PRESENTED BY
AYESHA IFTIKHAR
ROLL# 19010920-074
What is Positive Externality?
A positive externality exists if the production and
consumption of a good or service benefits a third
party not directly involved in the market
transaction.
Social Benefit of Positive
Externalities
With positive externalities, the benefit to society is greater
than your personal benefit.
Therefore with a positive externality the Social Benefit >
Private Benefit
Remember Social Benefit = private benefit + external
benefit.
Positive Externality (consumption)
Positive Externality occurs when the consumption of a good
causes a benefit to a third party.
For example:
You are able to educate other people and therefore they
benefit as a result of your education.
Diagram of Positive Externality
(consumption)
Positive Externality (production)
Positive Externality occurs when a third party benefits from
the production of a good.
For example
If a company develops new technology, such as a database
programmed, this new technology can be implemented by
other firms who will gain a similar boost to productivity.
Diagram of positive externality in production
Dealing with positive
externalities
Positive externalities lead to under-consumption and market
failure. Government policies to increase demand for goods with
positive externalities include
Rules and regulations
Increasing supply
Subsidy to reduce price and encourage consumption
Questions?
Solution of externalities
PRESENTED BY
SARIM RIAZ
ROLL# 19010920-108
Solutions to Externalities
Due to the adverse effect of both negative and positive
externalities on market efficiency, economists and
policymakers intend to address the problem. The
“internalization” of the externalities is the process of adopting
policies that would limit the effect of the externalities on
unrelated parties. Generally, the internalization is achieved
through government intervention. Possible solutions include
the following:
Solutions to Externalities
1. Defining property rights
The stricter definition of property rights can limit the
influence of economic activities on unrelated parties.
However, it is not always a viable option since the ownership
of particular things such as air or water cannot be
unambiguously assigned to a particular agent.
Solutions to Externalities
2. Taxes
A government may impose taxes on goods or services that create
externalities. The taxes would discourage activities that impose
costs on unrelated parties.
Solutions to Externalities
3. Subsidies
A government can also provide subsidies to stimulate certain
activities. The subsidies are commonly used to increase the
consumption of goods with positive externalities.
Questions?
Private Solutions to
Externalities
PRESENTED BY
Rizwana Liaqat
Roll# 19010920-073
Private solution to externalities
Definition
Private solutions to externalities include moral codes, charities, and
business mergers or contracts in the self interest of relevant parties.
Types of private solution:
a) Moral codes and social sanctions, e.g., the “golden rule”
b) Charities, e.g., the Sierra Club
c) Contracts between market participants ant the affected by standards
Private solution to externalities
The Coase Theorem:
If private parities can costless bargain over the allocation of resources,
they can solve the externalities problem on their own
The Coase theorem states that when transaction cost are low, two parties
will be able to bargain and reach efficient outcome in the presence of an
externality.
Transaction cost:
The cost incurred in making an economic exchange, such as
the cost required to come to an acceptable agreement with
the other party to the transaction, drawing up an appropriate
contact and so on.
Coase theorem:
The theorem states that private economic actors can solve the
problems of externalities among themselves.
The Coase theorem: an example
Dick owns a dog named Spot.
Negative externality:
Spot`s barking disturbs Jane, Dick`s neighbor.
The socially efficient outcome maximizes Dick`s + Jane`s
well being.
If Dick values having Spot more than Jane value peace &
quiet, the dog should stay.
Why private solution do not always work
1. Transaction cost :
The cost parties incur in the process of agreeing to end and following through
on bargain. These costs may make it impossible to reach a mutually beneficial
agreement.
2. Stubbornness:
Even if a beneficial agreement is possible, each party may hold out for better
deal.
3.Coordinating problems:
If# of parties is very large ,coordinating them may be costly, difficult, or
impossible.
Questions?
