Maktab Sains Paduka Sert Begawan Form 5 Economics EXTERNALITY What is it? Externalities are the costs and benefit which results from the firm's operations but which are paid for by (give benefits to) the third parties. The include the external costs such as pollution and congestion and external benefits such as the improvement in the general appearance of « shopping area when new shops are open up in previously abandoned premises. Private costs The costs incurred by a firm producing goods and services. For example, private cost will include wages and salaries, interest and cost of materials and components, as well as any research any development costs. Private benefits Private benefits are the benefits, which go to the individual buyer and seller of a product. Social cost Measures the cost to the whole society of a production process or business decision. This means that not only are the firm’s internal costs accounted for, but also the costs imposed on society as a consequence of the action, such as pollution or unemployment (external costs) Social benefits Are all the benefits from consumption of a particular item, not just those received by the buyer. They therefore include the external benefits, which may be obtained by third parties, i.e. people who neither bought nor sold the item. For example, the social benefits of a front pretty garden include the benefits obtained by the owner of it, together with the benefits of any passersby who happen to enjoy looking at the garden.Eternalities Negative externalities Positive externalities ‘With a negative externality, With a positive externality, such as pollution, the social the social benefits is bigger cost is greater than the private than the private benefit. cost. te MISALLOCATION OF RESOURCES RESULTS IN (itis where resources are not allocated properly) HOWTO OVERCOME EXTERNALI 1, Voluntary agreements “To agree on particular forms of behaviour, e.g, you agree with your neighbours that you will not make too much noise; alternatively they agree not to plant trees in their gardens which block out your sunlight in some cases these agreements may involve payment; you want to make noise; they don’t want you to, so they pay you to reduce your volume. 2. Tradeable permits In a system of tradeable permits, polluters are granted permission to create certain amount of pollution, Polluters can sell or buy permits from each other depending upon the amount of pollution they want to create. The aim is to fix the total amount of pollution within that firms can bargain among themselves to buy the permits they need. Firms which really need/want saue potnits will bid up the price and buy them from organizations which do not need them so much,"