Negative Externalities

1
Negative Externalities
2
Costs of Addiction

• April 28, 2006
• Canada racks up C40 billion in annual costs
  attributable to alcohol and other drug addiction,
  according to the Canadian Center on Substance
  Abuse. CBC News reported April 26 that the tally
  includes health-care costs, lost productivity,
  and the expense of court cases and prison.
  Tobacco addiction alone cost Canadian taxpayers
  an estimated 17 billion a year.
• "It's a sort of a wake-up call for us to rethink
  how we're addressing the issues of substance
  abuse in Canada," said the Center's Jacques
  LeCavalier.
• The study estimated alcohol-related costs at
  14.6 billion, and illicit-drug costs at 8.2
  billion.
• However, the study did not include government tax
  revenues from alcohol and tobacco sales as an
  offset.
• Researchers said 43,162 Canadians died from
  addiction-related causes in 2002 tobacco use
  accounted for 37,209 of those deaths.
• In this note we consider some of the external
  costs that can result from people consuming goods
  and services and businesses supplying products.
• Externalities are third party effects arising
  from production and consumption of goods and
  services for which no appropriate compensation is
  paid.
• Externalities occur outside of the market i.e.
  they affect economic agents not directly involved
  in the production and/or consumption of a
  particular good or service.

3
Negative Externalities
4
Negative Externalities

• Negative externalities occur when production
  and/or consumption impose external costs on third
  parties outside of the market for which no
  appropriate compensation is paid.
• Smokers ignore the unintended but harmful impact
  of toxic passive smoking on non-smokers
• Acid rain from power stations in the US can
  damage the forests of Muskoka
• The social costs of drug and alcohol abuse
• External costs of traveling by taxi.
• The environment damage caused by the intensive
  use of fertilisers in agriculture
• The external costs of cleaning up from litter and
  the dropping of chewing gum.

5
Graph It
Assume that a portion of the price is the cost to
society. Demand is written assuming there are no
societal benefits or costs for consumption.
Hold demand constant.
6
Graph It
With no externalities, the private costs of the
supplier to supply the good (supply curve) are
the same as the private costs for society.
(private cost supply)
7
Graph It
But if there are negative externalities, we must
add the external costs to the firms supply curve
to find the social cost curve. (We are driving up
the cost at all levels of production.)
8
Graph It
If the market fails to include these external
costs, then the equilibrium output will be Q1 and
the price P1. A socially-efficient output would
be Q2 with a higher price P2. At this price
level, the external costs have been taken into
account.
9
Graph It
We have not eliminated the pollution (we cannot
do this) but at least the market has recognized
them and priced them into the price of the
product. How do you get to the social cost
curve? Tax the item with an indirect tax.
10
Market Failure and the Environment
- Consumption of Goods and services is
detrimental to environment - The question is to
what degree is output sustainable - More
developed countries use proportionally more
resources than less developed countries - At the
same time, MDCs are developing technologies to
use fewer resources - The graph for market
failure (of polluting good or service) is the
same is basically one of negative
externalities. - The debate on growth,
development and the environment is really in its
infancy. - Environmentalists and capitalists
disagree. - For our purposes, expect that the
costs of negative environment externalities will
be increasingly factored into the costs of
products.