Unit 1 Micro: Positive and Negative Externalities (AQA)

At an AQA online AS feedback session this afternoon there was a suggestion that demerit goods should only be shown with negative externalities in consumption, i.e. with a divergence between marginal private benefits and marginal social benefits. Whilst the mark scheme currently accepts both this and external costs for explaining a demerit good, it was suggested that this would be changing to only allow the consumption (dis-benefits) issue.

This area of the AQA specification has been updated recently and reads:

Positive and Negative Externalities in Consumption and Production

Candidates should understand that externalities exist when there is a divergence between private and social costs and benefits and that negative externalities are likely to result in over-production.
Candidates should be able to illustrate the misallocation of resources resulting from externalities in both production and consumption, using diagrams showing marginal private and social cost and benefit curves.

Merit and Demerit Goods

Candidates should understand that the classification of merit and demerit goods depends upon a value judgement and that such products may also be subject to positive and negative externalities in consumption. They should also understand how under-provision of merit goods, and over-provision of demerit goods may result from imperfect information.
Candidates should be able to illustrate the misallocation of resources resulting from the consumption of merit and demerit goods using diagrams showing marginal private and social cost and benefit curves.

In further clarification of this issue, Stuart Luker presented the view that demerit goods should be illustrated as a negative externality in consumption.

According to AQA, students should be aware that consumption externalities lead to a divergence of MPB & MSB curves and production externalities lead to a divergence of MPC & MSC curves.

For example, if I choose to drink alcohol I estimate the private benefits to me (ignoring for the moment any information failure upon my part), but I do not consider the idea that my consumption creates a dis-benefit to others, and leads to the marginal social benefits of my consumption being lower than the marginal private benefits. Whilst this results in overconsumption, it does require a clarity of presentation to students for them to grasp this issue and if the statement from AQA is correct, it will require a specific diagram in the near future.

Summary of AQA information

MSC > MPC: negative externalities in production
MPC > MSC: positive externalities in production
MPB > MSB: negative externalities in consumption
MSB > MPB: positive externalities in consumption

If you have access to e-AQA, or simply the mark scheme from ECON1 in June 2011, you will see the two diagrams that are being accepted. The mark scheme develops the analysis for negative consumption externalities as the expected response, which is the future as stated by AQA.