-a cost or benefit that arises from production and falls on someone other than the producer OR a cost or benefit that arise consumption and falls on someone other than the consumer
-ex: going to college and earning a degree benefits not only me but also society
Allocative Efficiency
-where MC=MB (satisfies allocative efficiency) --> may only include private costs and benefits
-using resources where they are most highly valued
Types of Externalities
-positive production externality
-negative production externality
-positive consumption externality
-negative consumption externality
Positive Production Externality
-external benefit of production
-Ex: smelling the delicious sweets when walking into the mall without having to go to Cinnabon and purchase a sweet
-Ex: bees generate an external benefit for orchards and beekeepers. Bees need pollen in order to create honey, and the orchard supplies the pollen. The orchard gets the benefit too because the only way trees grow is with the pollen the bees transfer to the trees (to produce fruit). Orchard owners nor the bee keepers have to pay each other
Negative Production Externality*
-external cost of production
-Ex: pollution emitted from a production

-allocative efficiency: MSB=MSC
-MSC>MC (production externality-cost to society is higher than private cost)
MSC=sum of private and social costs
-Deadweight Loss:

1. Coase Theorem
assign property rights

-private transactions (no government regulations) are efficient if:
1.property rights exist (air, water, etc.// need an owner)
2.small number of people involved
3.transaction costs (costs of making a transaction//gas spent to reach destination) are low

2. Pigovian Taxes
-tax set equal to the marginal external cost
-impose tax=Marginal external cost
-sellers will try to charge the price + external cost (MSC)
3. Market for Pollution Permits
-government "owns" airs and sells "permits" for pollution
-cost of permit firm will pollute
-cost of permit > the cleanup of pollution --> cleans up pollution itself
-"cap and trade"// government caps
Positive Consumption Externality*
-external benefit to consumption
-Ex: education generates benefits for other people around you
-ex: immunizations keep others around you from getting infected
-Ex: deodorant

-demand curve reflects (private) MB
-MSB=MB+marginal social benefit
-inefficient at equilibrium (deadweight loss)
-wants market to produce more rather than less (like with negative production externality)

1. Subsidies and Vouchers
-subsidize consumers// set subsidy=Marginal external benefit
-private benefits will now equal the MSB
2. Assign property rights (positive consumption externalities)
-Ex: assign property rights to parents
3. Public provision
-tax society to pay for provision of good or service
ex: free education
Negative Consumption Externality
-external cost of consumption
-Ex: cigarette smoking if you are not a smoker is unpleasant
-Ex: someone throws a party (noisy) while you're trying to study for an exam.
Characteristics of Goods
nonexcludable: essentially costly to prevent someone from enjoying the benefits of a good, service, or resource
-cannot exclude someone from (using) enjoying benefits of good

excludable: possible to prevent someone from (using) enjoying the benefits of a good, service, or resource

rival: use by one person reduces the Q that is available to other people

nonrival (public goods): use by one person does not reduce the Q that is available to another person// obtaining an education

Categorizing Goods
-excludable and rival: private goods
-excludable and nonrival: natural monopoly
-nonexcludable and rival: common resources
-nonexcludable and nonrival: public goods
Free Goods
-no incentive to get someone to pay for a (public) good, resource, or service
-enjoy the benefits of a good without paying for it
-the summation of all individual MB's
Public Goods --> Rival (Common) Goods
-public goods are overused and the quantity decreases after people's use
-ex: highway --> congested highway
Private Mosquito Company
-is a public good
-would cover 0 miles of mosquito spray because their revenue would be $0 and everyone benefits from service without having to pay for it.
-no incentive to cover any square miles
Solutions for Common Goods
-assign property rights
-set quotas// limit the number
-individual transferable quotas