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Negative externalities

Explore the concept of negative externalities through the example of a market for plastic bags and its associated external costs, such as litter and environmental damage, that reduce the overall benefit to society. See how taking these costs into account would lead to a lower equilibrium quantity in order to maximize total benefit. Created by Sal Khan.

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  • leaf green style avatar for user Mohammed Ibrahim
    marginal benefit and marginal cost what are these two terms?
    (6 votes)
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  • blobby green style avatar for user a96941221
    Can you explain what is " the Coase Theorem"
    (7 votes)
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    • leaf yellow style avatar for user Tejas
      A legal and economic theory that affirms that where there are complete competitive markets with no transactions costs, an efficient set of inputs and outputs to and from production-optimal distribution will be selected, regardless of how property rights are divided. Coase theorem asserts that when property rights are involved, parties naturally gravitate toward the most efficient and mutually beneficial outcome.
      The Coase theorem states that where there is a conflict of property rights, the involved parties can bargain or negotiate terms that are more beneficial to both parties than the outcome of any assigned property rights. The theorem also asserts that in order for this to occur, bargaining must be costless; if there are costs associated with bargaining (such as meetings or enforcement), it will affect the outcome. The Coase theorem shows that where property rights are concerned, involved parties do not necessarily consider how the property rights are granted if they can trade to produce a mutually advantageous outcome. .

      Courtesy: Investopedia
      (10 votes)
  • blobby green style avatar for user chereegriffin
    is pollution considered an externality
    (5 votes)
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  • leaf green style avatar for user Barbie Rodriguez
    Why is the marginal supply curve upward sloping? I can see the Total supply curve being upward sloping, but as you produce more bags, the Fixed Costs would decrease per bag but the variable cost would remain the same or decrease.
    (6 votes)
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    • blobby green style avatar for user Wendy Williams
      There are two questions here--one about the supply curve and one about the MC curve. The supply curve represent the quantities of a product that sellers are willing to supply at various prices. As the price increases, sellers are willing to sell more of their product. Since they can sell their product at a higher price they are willing to work harder and/or take on more expenses to provide more of the product. If we make certain assumptions about the nature of the market (no monopolies, for example) and the nature of the product then the quantity sellers are willing to sell will be the quantity where their MC=MR (the extra cost for producing one more unit equals the extra revenue from selling one more unit). In this case we can say the MC curve represent the supply curve. Note, not all MC curves are upward sloping and in some cases MC equals zero or is close to zero. The upward sloping MC curve represents the usual MC curve in typical situations and is used in the introduction to the idea of "marginal" costs. Economists use the term "marginal" where a mathematician would say "first derivative" (from calculus). MC is the first derivative of total costs. Since the MC curve measures the slope of the total cost curve, the slope (positive, negative or flat) of the MC curve depends on the slope of the total cost curve. The slope of the total cost curve depends on the prices of inputs and the production function. (Inputs are the things a supplier needs to buy in order to make and sell the product--like workers and energy and raw materials. The production function identifies how many units of inputs are needed to produce a certain number of units of the product.)
      (7 votes)
  • leaf green style avatar for user Kris Kalavantavanich
    What is 'Aggregate total Benefit'? Sal mention that at .
    (7 votes)
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  • male robot donald style avatar for user Jack
    at , and i should of asked this by the first few vids but, why do we keep on saying that the more supplied the more the cost is (for supplier), isnt it the opposite? the more plastic bags i will make in one shot the less each piece would cost me?
    Thanks a Mill
    (4 votes)
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    • aqualine ultimate style avatar for user Elisha Smith
      This is taking into account the law of diminishing marginal returns. Say the plastic bag company has one factory. As more and more workers are added to the factory they become less and less efficient (as the factory starts to get cramped) so the additional units of production gained from each additional worker is decreasing therefore each unit costs more.
      (4 votes)
  • blobby green style avatar for user NicoleK.Batista
    examples of public goods
    (4 votes)
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  • blobby green style avatar for user Ebata
    Can negative externality generate a positive optimal level? Say the activity that creates the negative externality has its positive value, and the cost of reducing this activity too greatly will outweigh the additional benefits of reducing the externality.
    (3 votes)
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    • starky ultimate style avatar for user Geoff Ball
      The appropriate amount of output is when the negative externality is exactly internalized. Easier said than done, as that can be difficult to calculate. Essentially, when those external to the transaction are now adequately factored into the transaction, that's the optimal level of output.

      Take a factory that's dumping pollution in the river. There's a negative externality, as the people downstream are external to the transaction (they're not buying or selling anything involved with the factory), but are suffering from the pollution. One way to correct the externality is for the government to charge a tax on what the factory is selling. This raises the price, meaning less is demanded (and therefore less is sold). This corresponds to a social demand curve that is inside the private demand curve (closer to the origin). Although you might think the price is lower, don't forget to include the tax, which raises the price above the private market price.

      What the government does with the tax dollars isn't really important to this, although one would hope it would go toward pollution reduction, paying the people who live downstream, or something else relevant to the pollution. What matters is there is a lower quantity sold, which has internalized the externality. We are now at the social optimum.
      (3 votes)
  • leaf green style avatar for user Gaurav
    Isn't the space between the two equilibrium lines the deadweight loss ?. What am i missing here?
    (4 votes)
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    • leafers ultimate style avatar for user Tony Zheng
      It is important to make the distinction between total "private" surplus (private benefits minus private costs), and total "social" surplus (social benefits minus social costs).

      At market equilibrium P=2 (), the white area is the total private surplus, and the yellow area minus the purple area is the total social surplus.

      The difference between the total private surplus and total social surplus is the area in between the white and green curves, so I can understand how you could think that this area is a deadweight loss.

      But in reality we cannot move from the lower surplus to the higher surplus to gain efficiency, because they are two different types of surpluses.

      Only the purple area is deadweight loss, because if we move to P=3.5 we can move from a lower total social surplus to a higher total social surplus, and the difference is the area of the purple area.
      (1 vote)
  • leafers ultimate style avatar for user b3hr057
    I don't understand how a monetary value can be given to something like the negative effect of plastic bags on the environment. Do we just agree that every sea turtle or seagull choking on a plastic bag is equal to -$.01 or -$1.00? How are the actual amounts equated and who decides what environmental impact is worth what? Or is this just financial impact on a company that will have to clean up plastic bag waste after sufficient damage is done?

    I think I understand the concept of negative externalities, but I fail to understand how EVERYTHING could possibly be equated to a monetary amount somehow. There must be things that are beyond the scope of microeconomics to quantify. Doesn't this cross over into the realm of ethics and sociology?
    (2 votes)
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    • ohnoes default style avatar for user Tejas
      We normally can't give a monetary value, but we do know that one exists; it is just very hard to find. It normally means the amount of money that a government would have to spend to clean up the environment and the lowered production of society due to the environmental degradation.
      (2 votes)

Video transcript

Let's think about the market for plastic bags. And I'm picking this market in particular because there might be some cost associated with plastic bags that aren't captured when you're only looking at it from the point of view of the suppliers or the consumers. So right over here, you have a demand curve. And that's really the demand coming from the supermarkets. So this is the demand curve. You could also view it as marginal benefit. So that very first bag that gets produced, a supermarket gets a lot of marginal benefit. They'd really want to get that bag, because then they could give it to the people who shop at the supermarket, and they can carry their bags home. But then each incremental bag after that, the marginal benefit gets lower and lower and lower. And this green curve over here-- we've seen this multiple times-- that is our supply curve, which we can also think of it as our marginal cost curve. To produce the very first bag, the opportunity cost for that very first bag is about, looks like about a penny per bag. And then it gets higher and higher and higher as you produce more and more bags. And we have an equilibrium price and an equilibrium quantity. Our equilibrium quantity looks like it's about 3 and 1/2 million bags. We have an equilibrium price of about $0.02 per bag. And if this were all of the cost and all of the benefits, then this area right over here would show the total, the aggregate total benefit that the ecosystem here, that the suppliers and the consumers, or the supermarkets or the consumers in this case, are getting from this transaction. Marginal benefit higher than marginal cost; marginal benefit higher than marginal cost. This whole area is our total surplus, and we've seen that multiple times. But now let's think about that added cost that plastic bags have that are not factored in to the cost and the prices, or the cost and the benefits right over here. Plastic bags have a negative externality. There's a cost associated. So it's negative because there's a cost associated with plastic bags that is not being borne by either in this situation, that is not being factored into the marginal cost curve. You can also have positive externalities, which are a benefit. Maybe you're talking about the market for trees, and society benefits when more plants or more trees are being planted, or whatever. And let's just say-- And that negative externality, that's coming from obvious things. You know, these bags are going to be litter. They're going to be on the side of the highway. The city has to clean them up. There's environmental risks due to them. Animals might eat them and choke on them, and turtles might drown, and whatever else, because they're choking on plastic bags and whatever else. And so they hire some experts. And this is not an easy thing to do, but it's determined that the negative externality of these plastic bags is $0.02 per bag. Or another way to think of it, the cost to society and the environment above and beyond the marginal cost to the producers, is $0.02 per bag. Now, given that, if we assume this statement right over here-- and it's not an easy thing to come up with this number-- but if we assume that this number is true, what then is the optimal amount of bags to purchase? And what are we actually doing if we-- What is the optimum amount of bags to produce? And what are we doing when we do produce this much? And to think about that, let's create a new curve. This is the supplier's marginal cost. Let's create another curve that is the supplier plus society's marginal cost. So that first bag supplier, his opportunity cost is about a penny, but for society it's costing another $0.02. So supplier plus society is costing almost $0.03. And so we can plot out another curve which we can view as the supplier plus society marginal cost. So now we can think of things in terms of total benefit, or total net benefit, I guess, that's happening. That very first bag, the supermarket that buys it is still getting that over $0.05 of benefit. But now if we think about the net benefit to society, it's not this whole height all the way down to a penny. It's only this part right over here. It's only the difference between five and three is the marginal net benefit, if you take the marginal benefit and you subtract out the total marginal costs, including the externalities. And so the next bag, the total cost gets a little higher, the marginal benefit gets a little bit lower. And you keep, it makes sense for society-- It will keep getting benefit from this, if we think of the entire ecosystem, will keep getting benefit until we hit this other equilibrium point over here. And once we get past that equilibrium point, now when we think holistically, when we think of the environment and the government and all of that, now all of a sudden the marginal cost of each incremental unit is higher than the marginal benefit. So if we were to produce beyond that, now we're incurring costs. Now we're essentially eating out all of the benefit that we would have gotten. And if we were to produce all the way to our old equilibrium point over here, we more, in the way-- I was just eyeballing it, the purple area is more than the yellow area-- we're now getting a negative total benefit to society. Or you could say a negative total surplus. And we haven't visualized it this way in the past. It's unusual for us to see a dead weight loss on this side of the equilibrium point, but you can also view it that way. So this right over here is negative surplus. And so what you really want holistically if you are the benevolent emperor of the society, and you really want to factor in all of the costs and benefits of the plastic bags, the ideal thing if you want to optimize the benefit in society, you would want the equilibrium price to be around here-- that looks like about 350-- and the equilibrium quantity to be-- this looks about 1.8 million. And you would not want all of this excess quantity that is taking away, that is less efficient for society.