cem101
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why is it that goods with a negative externality are overproduced and goods with a positive externality are underproduced?
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gr8wizard10
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Goods with negative externalities (De-merit goods) i.e. Cigaretters, Production work which causes carbon emissions, alcohol.

These goods are over-produced/under-charged if left to a free market. Marginal Private Cost of production is not equivalent to what's considered to be the socially optimum level of output. Taxes can be implemented to shift the MPC to the right to try and equate the MSC to lessen the deadweight loss. The reason goods with negative externalities are over produced is that consumers/manufacturers don't initially see the negative effects of such products (usually de-merit goods) and will continue producing oblivious to negative externalities. Firms won't pay extra just because they pollute although in theory they should pay for that externality being produced to internalise the externality. That's why governments must step in and impose tax/permits etc.. and supply side policies to help pay for the externality.

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Goods with positive externalities (Merit goods) i.e Gym, education & training

These goods are under-produced and under-priced if left to free market forces. These goods provide positive externalities in consumption. By gaining an education it's more beneficial to society as a whole. However these goods are normally under-provided as the effects are usually seen in the long-term and people would be reluctant to pay the initial costs. The governments have made schools available to children to reap the long-term benefits. These goods are under-provided in the free market as people don't see the positive externalities in consumption in the short-term. It would be socially beneficial if society produces more of this good and people are charged a higher price because they are gaining more out of these goods then what they are paying. There paying MSC=MPB where they are actually getting MSC=MSB.

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Added diagrams to help give a clearer image. Hope this helps in some way. :rolleyes:
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cem101
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(Original post by Abdul-Karim)
Goods with negative externalities (De-merit goods) i.e. Cigaretters, Production work which causes carbon emissions, alcohol.

These goods are over-produced/under-charged if left to a free market. Marginal Private Cost of production is not equivalent to what's considered to be the socially optimum level of output. Taxes can be implemented to shift the MPC to the right to try and equate the MSC to lessen the deadweight loss. The reason goods with negative externalities are over produced is that consumers/manufacturers don't initially see the negative effects of such products (usually de-merit goods) and will continue producing oblivious to negative externalities. Firms won't pay extra just because they pollute although in theory they should pay for that externality being produced to internalise the externality. That's why governments must step in and impose tax/permits etc.. and supply side policies to help pay for the externality.

Name:  negext_p_f.gif
Views: 684
Size:  2.8 KB

Goods with positive externalities (Merit goods) i.e Gym, education & training

These goods are under-produced and under-priced if left to free market forces. These goods provide positive externalities in consumption. By gaining an education it's more beneficial to society as a whole. However these goods are normally under-provided as the effects are usually seen in the long-term and people would be reluctant to pay the initial costs. The governments have made schools available to children to reap the long-term benefits. These goods are under-provided in the free market as people don't see the positive externalities in consumption in the short-term. It would be socially beneficial if society produces more of this good and people are charged a higher price because they are gaining more out of these goods then what they are paying. There paying MSC=MPB where they are actually getting MSC=MSB.

Name:  positive-externality1.jpg
Views: 1437
Size:  21.5 KB

Added diagrams to help give a clearer image. Hope this helps in some way. :rolleyes:
thanks!!!
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