Negative Externalities of Consumption Where the consumption of goods has spill over costs, the consumers does not fully take account of the total costs to society. ECO 13/4/3

Negative Externalities of Consumption An example could be the consumption of alcohol. While low levels of consumption may cause little or no effect on others as a consumer increases the level of consumption it can result in costs to others such as drinking driving resulting in an accident.

Negative Externalities of Consumption for Individual Consumer The drinker considers their private cost and benefit and will consume Qm where MC=MB at a price of Pm. The spill over costs impact on other individuals, in effect reducing the overall benefit to society. This is shown with a lower Marginal Social Benefit Curve giving a lower Marginal Social Benefit MSB. The gap increases, as there are more spillover costs as consumption increases MC MB MSB Qm Pm

Negative Externalities of Consumption for Individual Consumer The market failure is the “over consumption” of the alcohol as the private consumer does not take into account all the costs. This results in spill-over costs MC MB MSB QmQs Psd Pm When all the costs are taken in to account the Socially Desirable outcome would be less consumption at Qs. Spill-over costs

Negative Externalities of Consumption for Individual Consumer This results in a dead weight loss for society MC MB MSB QmQs Psd Pm There is a loss of efficiency as consumption has occurred where the costs of production exceed the benefit to society MC>MSB DWL

Total Surplus Qm Negative Externalities of Consumption for Individual Consumer As we have already seen there are spillover-costs at Qm MC MB MSB QmQs Psd Pm The Total CS and PS at Qm is greater than the total surplus at Qs, resulting in a gain in surplus As the spill-over costs exceed the gain in surplus there is a loss in efficiency, a DWL Total Surplus Qs DWL

Negative Externalities of Consumption The typical solution is a tax. The tax required to achieve Qs would be found as the vertical distance between the MSB and MB curves at Qs. The total tax would be the rectangle formed by the tax and Qs MC MB MSB QmQs Pm Tax required The tax on producers increases the MC, and the resulting increase in price will move consumption to Qs MC+tax

Negative Externalities of Consumption The costs of the tax are a loss of CS and PS that is not reallocated to the government. MC MB MSB QmQs Pm The tax decreases the spill-over costs MC+tax The cost of the tax is smaller than the efficiency gain of reduced spill-over costs, resulting in an overall gain in efficiency that eliminates the DWL Efficiency Gain

External Cost Negative Externalities of Consumption Internalising the Externality By making the costs of the firm increase to reflect the external costs, these spill over costs have become internal costs. Internal: Private costs to consume

Negative Externalities of Consumption Other solutions could be  Regulation – drinking age  Price controls – min prices on RTD  Education

Negative Externalities of Consumption To be totally effective, the tax should be used to pay for the costs of alcohol born by others. For example, it could be used to support shelters for victims of family violence.