Editing Externality (section)

==Supply and demand diagram==
The usual economic analysis of externalities can be illustrated using a standard [[supply and demand]] diagram if the externality can be valued in terms of [[money]]. An extra supply or demand curve is added, as in the diagrams below. One of the curves is the ''private cost'' that consumers pay as individuals for additional quantities of the good, which in competitive markets, is the marginal private cost. The other curve is the ''true'' cost that society as a whole pays for production and consumption of increased production the good, or the marginal [[social cost]]. Similarly, there might be two curves for the demand or benefit of the good. The social demand curve would reflect the benefit to society as a whole, while the normal demand curve reflects the benefit to consumers as individuals and is reflected as [[effective demand]] in the market.

What curve is added depends on the type of externality that is described, but not whether it is positive or negative. Whenever an externality arises on the production side, there will be two supply curves (private and social cost). However, if the externality arises on the consumption side, there will be two demand curves instead (private and social benefit). This distinction is essential when it comes to resolving inefficiencies that are caused by externalities.

===External costs===
[[File:Negative externality.svg|384px|right|thumb|Demand curve with external costs; if social costs are not accounted for price is too low to cover all costs and hence quantity produced is unnecessarily high (because the producers of the good and their customers are essentially underpaying the total, real [[factors of production]]).]]
The graph shows the effects of a negative externality. For example, the [[steel industry]] is assumed to be selling in a competitive market – before pollution-control laws were imposed and enforced (e.g. under [[laissez-faire]]). The marginal private cost is less than the marginal social or public cost by the amount of the external cost, i.e., the cost of [[air pollution]] and [[water pollution]]. This is represented by the vertical distance between the two supply curves. It is assumed that there are no external benefits, so that social benefit ''equals'' individual benefit.

If the consumers only take into account their own private cost, they will end up at price '''P<sub>p</sub>''' and quantity '''Q<sub>p</sub>''', instead of the more efficient price '''P<sub>s</sub>''' and quantity '''Q<sub>s</sub>'''. These latter reflect the idea that the marginal social benefit should equal the marginal social cost, that is that production should be increased ''only'' as long as the marginal social benefit exceeds the marginal social cost. The result is that a [[free market]] is ''[[inefficiency|inefficient]]'' since at the quantity '''Q<sub>p</sub>''', the social benefit is less than the social cost, so society as a whole would be better off if the goods between '''Q<sub>p</sub>''' and '''Q<sub>s</sub>''' had not been produced. The problem is that people are buying and consuming ''too much'' steel.

This discussion implies that negative externalities (such as pollution) are ''more than'' merely an ethical problem. The problem is one of the disjunctures between marginal private and social costs that are not solved by the free market. It is a problem of societal communication and coordination to balance costs and benefits. This also implies that pollution is not something solved by competitive markets. Some ''collective'' solution is needed, such as a court system to allow parties affected by the pollution to be compensated, government intervention banning or discouraging pollution, or economic incentives such as [[green tax]]es.

===External benefits===
[[File:Positive externality.svg|384px|right|thumb|Supply curve with external benefits; when the market does not account for the additional social benefits of a good both the price for the good and the quantity produced are lower than the market could bear.]]
The graph shows the effects of a positive or beneficial externality. For example, the industry supplying smallpox vaccinations is assumed to be selling in a competitive market.  The marginal private benefit of getting the vaccination is less than the marginal social or public benefit by the amount of the external benefit (for example, society as a whole is increasingly protected from smallpox by each vaccination, including those who refuse to participate). This marginal external benefit of getting a smallpox shot is represented by the vertical distance between the two demand curves. Assume there are no external costs, so that social cost ''equals'' individual cost.

If consumers only take into account their own private benefits from getting vaccinations, the market will end up at price '''P<sub>p</sub>''' and quantity '''Q<sub>p</sub>''' as before, instead of the more efficient price '''P<sub>s</sub>''' and quantity '''Q<sub>s</sub>'''. This latter again reflect the idea that the marginal social benefit should equal the marginal social cost, i.e., that production should be increased as long as the marginal social benefit exceeds the marginal social cost. The result in an [[free market|unfettered market]] is ''[[inefficiency|inefficient]]'' since at the quantity '''Q<sub>p</sub>''', the social benefit is greater than the societal cost, so society as a whole would be better off if more goods had been produced. The problem is that people are buying ''too few'' vaccinations.

The issue of external benefits is related to that of [[public goods]], which are goods where it is difficult if not impossible to exclude people from benefits. The production of a public good has beneficial externalities for all, or almost all, of the public. As with external costs, there is a problem here of societal communication and coordination to balance benefits and costs. This also implies that vaccination is not something solved by competitive markets. The government may have to step in with a collective solution, such as subsidizing or legally requiring vaccine use. If the government does this, the good is called a [[merit good]]. Examples include policies to accelerate the introduction of [[electric vehicles]]<ref name="BuekersEV">{{cite journal |last1=Buekers |first1=Jurgen |last2=Van Holderbeke |first2=Mirja |last3=Bierkens |first3=Johan |last4=Int Panis |first4=Luc |title=Health and environmental benefits related to electric vehicle introduction in EU countries |journal=Transportation Research Part D: Transport and Environment |date=December 2014 |volume=33 |pages=26–38 |doi=10.1016/j.trd.2014.09.002 |bibcode=2014TRPD...33...26B |s2cid=110866624 }}</ref> or promote [[cycling]],<ref name="Buekers2015">{{cite journal |last1=Buekers |first1=Jurgen |last2=Dons |first2=Evi |last3=Elen |first3=Bart |last4=Int Panis |first4=Luc |title=Health impact model for modal shift from car use to cycling or walking in Flanders: application to two bicycle highways |journal=Journal of Transport & Health |date=December 2015 |volume=2 |issue=4 |pages=549–562 |doi=10.1016/j.jth.2015.08.003 |bibcode=2015JTHea...2..549B }}</ref> both of which benefit [[public health]].