Causes of the problem of externalities

On externalities, traditional economics uses Social Marginal Benefit (SMB) and Social Marginal Cost (SMC) to explain and illustrate. An important precondition for the market mechanism to make the optimal allocation of resources is that the production or consumption behavior of economic parties will not affect the welfare of others, i.e., Social Marginal Benefit (SMB) and Private Marginal Benefit (PMB) are equal, and Social Marginal Cost ( SocialMarginalCost, SMC) and Private Marginal Cost (PMC) are equal, i.e., SMB=PMB and SMC=PMC, and under this precondition, the optimal resource allocation of Pareto efficiency is realized (Figure 3-3). When the social marginal benefit and the individual marginal benefit will produce inconsistency, the difference between the social marginal benefit and the individual marginal benefit is the "positive externality" (XB in Figure 3-4); when the social marginal cost and the individual marginal cost inconsistency produces the difference is the "negative Externalities" (XC in Figure 3-5) [63]. The existence of externalities makes the social cost and private cost, social benefit and private benefit deviation, which leads to resource allocation is difficult to achieve Pareto optimality.

The effect of externalities is not market-mediated. Not only can this effect not be reflected through the production and price mechanism, but on the contrary, it also hinders the role of the market mechanism, so that the market mechanism can not effectively allocate resources according to Pareto efficiency. In Figure 3-4, the output that realizes the Pareto-optimal efficiency of resource allocation is X0, but when there is a positive externality, the output is shifted to X1, which does not constitute the optimally efficient output, and in Figure 3-5, in the case of negative externality, the output is shifted to X2, which also does not realize the Pareto-optimally efficient output. It can be seen that both positive and negative externalities lead to inefficient resource allocation.

Figure 3-3 Pareto-efficient optimization

Figure 3-4 Positive externality

Figure 3-5 Negative externality