<NEGATIVE EXTERNALITY OF CONSUMPTION>

--DEFINITION--

A NEGATIVE EXTERNALITY OF CONSUMPTION occurs when an INDIVIDUAL'S CONSUMPTION of a good or service decreases the well-being (CREATES EXTERNAL COSTS) of others (THIRD PARTIES) to whom they fail to COMPENSATE These goods are referred to as DEMERIT GOODS and this results in the OVERCONSUMPTION of this good.

-WHY ARE DEMERIT GOODS OVERCONSUMED?-

There are basically TWO REASONS why DEMERIT GOODS are OVERCONSUMED:-

- - FIRSTLY, if the CONSUMERS DO NOT NEED TO COMPENSATE (REIMBURSE) the third parties for the EXTERNAL COSTS then the PRICE THEY PAY will be LOWER than it should be and therefore QUANTITY DEMANDED will be HIGHER (and hence 'OVERCONSUMED') at each price level.

- - SECONDLY, because some of the CONSUMERS are IGNORANT (UNAWARE) about the FULL COST of the product to themselves such as FUTURE HEALTH ISSUES, THE MORAL IMPACT ON OTHERS, etc they will DEMAND MORE T ECH PRICE LEVEL.

--DIAGRAM--

--MPB > MSB--

If in THE PROCESS OF CONSUMING a good, there are EXTERNAL COSTS (or to put it another way 'NEGATIVE BENEFITS') to third parties that are NOT ACCOUNTED FOR IN THE CONSUMER'S PERCEIVED BENEFITS FROM CONSUMPTION, then the CONSUMER'S DEMAND CURVE only represents their PRIVATE BENEFITS (MPB) and therefore will not represent society's demand curve (MSB) which is equal to the PRIVATE BENEFIT LESS THE NEGATIVE BENEFITS or 'NET-BENEFIT' of this activity on society.
In other words, if we based the demand curve on the marginal price society is willing to pay per unit (as represented by the marginal net-benefit they expect to receive per unit) rather than the marginal price private individual consumers are willing to pay per unit (as represented by the marginal private benefit they expect to receive) we will derive TWO DEMAND CURVES, one representing society (MSB CURVE) and one representing the private consumers (MPB CURVE) with the MSB curve more to the LEFT.
IF WE ASSUME THE MSC CURVE IS FIXED then the equilibrium quantity transacted using the MSB curve is LESS THAN the equilibrium quantity transacted using the MPB curve.
Hence the free market output is GREATER THAN the socially optimal amount (MSB = MSC).
We can see in the diagram below, that the exclusion of negative benefits results in the consumer's demand curve (MPB) being to the RIGHT, of the MSB curve, (MPB>MSB) leading to OVERCONSUMPTION and a DWL.

--EXAMPLES--

--EXAMPLE #1: SMOKING--

An individual smoker's demand curve for cigarettes represents their own MARGINAL PRIVATE BENEFIT (MPB) that they expect to receive from CONSUMING each additional unit of cigarette.
However, the impact of PASSIVE SMOKING creates EXTERNAL COSTS (NEGATIVE BENEFITS) to 3rd parties (SOCIETY) such as health treatments, increased sick days, loss of work hours etc.... and yet the smoker DOES NOT COMPENSATE them.
If this negative benefit was deducted from the private benefits of smokers we would arrive at SOCIETY'S BENEFIT CURVE (MSB).
RWE: SINGAPORE TOBACCO TAX

--EXAMPLE #2: ALCOHOL--

An individual DRINKER's demand curve for alcohol represents their own MARGINAL PRIVATE BENEFIT that they expect to receive from CONSUMING each additional unit of alcohol.
However, the impact of ALCOHOL CONSUMPTION creates EXTERNAL COSTS (NEGATIVE BENEFITS) to 3rd parties such as health treatments, increased sick days, loss of work hours, cost of policing alcohol-related crimes, etc, and yet the drinker DOES NOT COMPENSATE them.
If this NEGATIVE BENEFIT WAS DEDUCTED from the private benefits of drinkers we would arrive at SOCIETY'S BENEFIT CURVE.
Alternatively, It may be easier to think of the impact on quantity demanded if the value of this negative benefit was charged directly to the consumer.

--EXAMPLE #3: SUGAR--

An individual SUGAR-CONSUMER's demand curve for SUGARY GOODS represents their own MARGINAL PRIVATE BENEFIT that they expect to receive from CONSUMING each additional unit of SUGAR.
However, the impact of EXCESSIVE SUGAR CONSUMPTION creates EXTERNAL COSTS (NEGATIVE BENEFITS) to 3rd parties such as health treatments, increased sick days, loss of work hours, cost to taxpayers etc.... and yet the consumer DOES NOT COMPENSATE them.
If this negative benefit was deducted from the private benefits of drinkers we would arrive at SOCIETY'S BENEFIT CURVE.

--EXAMPLE #4: PLASTIC BAGS--

--WHY PLASTIC BAGS CREATE NEGATIVE CONSUMPTION EXTERNALITIES--

--EXAMPLE #5: DIESEL CAR USAGE--

--TASK: 'ANTIBIOTICS'--

Watch the video below and REWRITE the following paragraphs using ANTIBIOTICS USAGE instead of CIGARETTES:

An individual smoker's demand curve for cigarettes represents their own MARGINAL PRIVATE BENEFIT (MPB) that they expect to receive from CONSUMING each additional unit of cigarette.
However, the impact of PASSIVE SMOKING creates EXTERNAL COSTS (NEGATIVE BENEFITS) to 3rd parties (SOCIETY) such as health treatments, increased sick days, loss of work hours etc.... and yet the smoker DOES NOT COMPENSATE them.
If this negative benefit was deducted from the private benefits of smokers we would arrive at SOCIETY'S BENEFIT CURVE (MSB).

--TASK 1--

IMAGINE THAT YOU ARE AN 'ANTI-SMOKING' ADVOCATE AND YOU WISH TO INCREASE THE BANNING OF SMOKING IN PUBLIC, IN PARTICULAR WITHIN 200M OF ALL SCHOOL PROPERTY. WRITE A LETTER TO THE LOCAL CONGRESSPERSON, EXPLAINING WHY SMOKING IS CREATING EXTERNAL COSTS AND RESULTING IN A MARKET FAILURE AND HOW A FURTHER BAN IS NECESSARY.
- DEFINITIONS: MARKET FAILURE, EXTERNAL COST, NEG. EXT OF CONSUMPTION
- DIAGRAM SHOWING MARKET FAILURE
- DIAGRAM SHOWING HOW BAN WILL IMPACT MARKET

--TASK 2--

IMAGINE THAT YOU ARE NOW THE CONGRESSPERSON WHO RECEIVED THE 'ANTI-SMOKING' ADVOCATE'S LETTER YOU AGREE THAT SMOKING IS A PROBLEM BUT YOU ARE NOT CONVINCED THAT A 'BAN' WILL BE VERY EFFECTIVE, AND YOU WISH TO SUGGEST OTHER SOLUTIONS THAT ARE ALREADY BEING IMPLEMENTED.
- DISCUSS WHY BANS MAY NOT BE SO EFFECTIVE
- EXPLAIN THE OTHER METHODS THAT ARE BEING USED
- SHOW IMPACT OF THESE METHODS ON ORIGINAL DIAGRAM
- MAKE SURE THAT YOU ARE BALANCED AND CRITIQUE EACH METHOD

--CORRECTIVE POLICIES--

--MARKET-BASED--

--INDIRECT (PIGOUVIAN) TAX ON OUTPUT...--

In order to reduce the quantity of the good consumed, governments can intervene by raising the price by imposing an 'INDIRECT TAX' on EACH UNIT OF OUTPUT PRODUCED, as such, it will add to the producer's unit cost of each item sold, and SHIFT THE MSC CURVE to the LEFT, creating a new curve called the MSC + TAX CURVE.
The quantity transacted at the new equilibrium is LOWER than the free-market level and ideally, it is equal to the Qso, thus CORRECTING THE OVERCONSUMPTION.

--PROS--

An INDIRECT TAX clearly increases the costs of production for a firm which in most cases will be passed on (In part) to the consumer and therefore LEAD TO A RISE in the PRICE and a FALL IN THE QUANTITY DEMANDED (and CONSUMED).
The GOVERNMENT CAN EARN REVENUE from the tax which they can SPEND ON MERIT GOODS.

--CONS--

LESS EFFECTIVE when dealing with INELASTIC GOODS. For example, DEMERIT GOODS such as cigarettes have ADDICTIVE QUALITIES, meaning any % rise in price will result in only a small % fall in Qd, as such only a VERY LARGE TAX will be useful.
REGRESSIVE in NATURE, as it will impact low-income earners more than high-income earners.
UNEMPLOYMENT may occur in the industry due to the fall in production, which may create external costs.
SUGARY DRINK PRODUCERS HAVE NO INCENTIVE TO REFORMULATE TO LOWER SUGAR CONTENT AND AVOID THE TAX as the tax is Imposed on UNITS PRODUCED rather than on SUGAR CONTENT.
IMPOSSIBLE TO DETERMINE THE CORRECT SIZE OF THE TAX, given that working out the exact size of the EXTERNAL COST is impossible, so too is the size of the tax to correct it, thus if it is too HIGH then it could cause UNDERCONSUMPTION to occur.

--PROS--

The tax RAISES THE PRICE which will REDUCE THE QUANTITY DEMANDED.
The tax is REGRESSIVE which means it will be MORE EFFECTIVE AT DISCOURGAING LOW INCOME CONSUMERS, which includes youngsters who in the case of smoking will be be less likely to TAKE UP THE BAD HABIT IN THE FUTURE.
As it is ADDICTIVE, its DEMAND is INELASTIC meaning the TAX REVENUE COLLECTED CAN BE SUBSTANTIAL which it can use to FUND EDUCATION to RAISE AWARENESS and LOWER MPB.

--...vs INDIRECT TAX ON SUGAR CONTENT--

If an INDIRECT TAX is applied to EACH UNIT OF SUGAR CONTENT CONTAINED WITHING THE DRINK (usually measured in grams), it will HAVE TWO EFFECTS:
- - - Firstly, firms that can't remove sugar from their drinks will see their COSTS OF PRODUCTION RISE, shifting their PRIVATE COST CURVE TO THE LEFT (Which equals the MSC, so we get a new MSC = MPC = MSC+TAX)
    - Secondly, firms will have the INCENTIVE TO AVOID THE TAX by REDUCING THE SUGAR CONTENT by REFORMULATING THEIR DRINKS. As a result, the average sugar content per unit should fall, lowering the negative benefit and shifting the SOCIAL BENEFIT CURVE TO THE RIGHT, closer the to MPB (as the size of the negative benefit per unit has now decreased)
BOTH these effects in theory result in the market output getting closer to the socially optimal level.

--PROS--

INCENTIVISES REFORMULATONS rather than a reduction in the units sold, as producers can avoid the tax by reducing the sugar content.
GREATER CONSUMER SURPLUS as more units are consumed at lower prices (Assuming the flavour stays the same)

--CONS--

Reduced sugar content may make the products flavour change which could result in FEWER SALES and revenue
Loyal customers may object to the change in sugar content which could lead to BAD PUBLICITY.

--COMMAND-BASED--

--LEGISLATION & REGULATION--

LEGISLATION & REGULATION refers to LAWS implemented that for the most part aim to REDUCE THE DEMAND for DEMERIT GOODS.
This results in a LEFTWARD SHIFT in the MPB CURVE.

--SODA BAN--

--AGE RESTRICTIONS ON BUYING TOBACCO--

--SMOKING FREE ZONES--

--ALCOHOL FREE ZONES--

--GENERATIONAL BAN--

--PROS--

Can be effective if ENFORCED REGULARLY and CONSEQUENCES ARE PROHIBITIVE.

--CONS--

The HIGH COST of ENFORCEMENT
Often BLACK MARKETS develop.
The FINE is set TOO LOW?
...

--OTHER APPROACHES--

--EDUCATION & AWARENESS CREATION--

This is also INTENDED TO REDUCE THE DEMAND FOR DEMERIT GOODS by making consumers or potential consumers more aware of the external costs of consumption.

--PROS--

CAN BE VERY EFFECTIVE IF ENFORCED REGULARLY AND CONSEQUENCES ARE PROHIBITIVE

--CONS--

NOT APPLICABLE TO MANY TYPE OF GOODS, SUCH AS SUGAR AND PETROL CONSUMPTION

--NUDGES--

A 'NUDGE' refers to a way of INFLUENCING CONSUMER'S CHOICES WITHOUT using the following:
1) FINANCIAL REWARDS for compliance.
2) SANCTIONS for non-compliance.
3) LIMITING CHOICES.

Nudges are designed to alter people’s behaviour without coercively forbidding options. As Richard Thaler and Cass Sunstein wrote in their 2008 book Nudge: “putting fruit at eye level counts as a nudge. Banning junk food does not”.

--PLAIN PACKAGING--

--MANDATORY NUTRITIONAL LABELLING--

--ENERGY CONSUMPTION LABELLING--

--PROS--

--CONS--

RFF-Resources-143-antibiotic.pdf

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