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# OCR F581 - Externality Diagrams Watch

1. Hello all!

I am a little confused over the Externality Diagrams for the F581 unit. I have not been taught the MSC,MPC/MSB,MPB diagram and therefore don't understand what it means. Please could someone help explain the diagrams? I understand how negative externalities occur when Social Costs exceed Private Costs for a particular action but i'm unsure how this is shown in a diagram.

Thanks!

P.S why does Supply shift left when a indirect tax is imposed on a good? Is it because it will cost more to produce the good and therefore less is produced?
2. Not sure about the graphs if i'm honest! But the supply curve will move to the left because it will add to the costs and also firms will see that demand may decrease, so they may switch resources to make goods that will be more profitable. Depends on elasticity of demand for an evaluative point. Good luck!
3. My teachers taught it to us, but made it clear that you do not 'need' to use it in an exam, it just allows you to do some extra analysis. Essentially, with a demerit good such as air travel the costs to society (MSC) exceed the costs to the individual (MPB), so you can draw two supply lines where the MSC is to the left of MPC. This means that you need to demonstrate a shift from the private equilibrium to the public equilibrium, like this http://12phorna.wordpress.com/2011/0...arket-failure/ The shaded bit is the 'deadweight loss', which is the costs that society pays, which is only paid for by the consumer if the MSC is taken into account. But yeah, you do not actually need to use this, and if you are unsure of the diagram in the exam just don't use it.

Yeah supply shifts left when a tax is applied because 'it increases the cost of production' (from a mark scheme)
4. They look nasty but once you understand them they're very simple and really helpful

Originally, there is overproduction of the demerit good as firms are only taking into account the costs to them (Marginal Private Costs). They is overproduction/consumption (Q1) and the price is too low as it does not reflect the true costs to society (P1)

If the true costs to society were taken into account, the supply would be shifted to the left as the costs to society are taken into account (Marginal Social Costs). There is now not overproduction of the good (Q1- Q Opt) and the price better reflects the true costs to society of the production/consumption of the good (P- P Opt). This creates a Welfare Gain to the society (Whee the arrow is) as well as creating a new socially optimum equilibrium

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Updated: May 16, 2013
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