Externalities In Consumption

The externalities we have discussed so far are associated with the production of goods. Some externalities, however, are associated with consumption. The consumption of alcohol, for instance, yields negative externalities if consumers are more likely to drive under its influence and risk the lives of others. Similarly, the consumption of education yields positive externalities because a more educated population leads to better government, which benefits everyone.

The analysis of consumption externalities is similar to the analysis of production externalities. As Figure 10-4 shows, the demand curve does not reflect the value to society of the good. Panel (a) shows the case of a negative consumption externality, such as that associated with alcohol. In this case, the social value is less than the private value, and the socially optimal quantity is smaller than the quantity determined by the private market. Panel (b) shows the case of a positive consumption externality, like that of education. In this case, the social value is greater than the private value, and the socially optimal quantity is greater than the quantity determined by the private market.

Once again, the government can correct the market failure by inducing market participants to internalize the externality. The appropriate response in the case of consumption externalities is similar to that in the case of production externalities. To move the market equilibrium closer to the social optimum, a negative externality requires a tax, and a positive externality requires a subsidy. In fact, that is exactly the policy the government follows: Alcoholic beverages are among the most highly taxed goods in our economy, and education is heavily subsidized through public schools and government scholarships.

As you may have noticed, these examples of externalities lead to some general lessons: Negative externalities in production or consumption lead markets to produce a larger quantity than is socially desirable. Positive externalities in production

(a) Negative Consumption Externality

(b) Positive Consumption Externality

Price of Alcohol

(a) Negative Consumption Externality

Price of Alcohol

Positive Consumption

Qoptimum Qmarket

Quantity of Alcohol

Figure 10-4

Qoptimum Qmarket

Price of Education

Quantity of Alcohol

(b) Positive Consumption Externality

Price of Education

Supply

(private cost)

>

: Social

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