There are four major types of externality; external costs of production, external benefits of production, external costs of consumption and external benefits of consumption.
External costs of production arise from marginal social costs, examples being pollution caused from production of a good or service. The marginal social cost exceeds the marginal private cost (MSC>MC). The problems of external costs arise in a free market economy where no one has legal ownership of rivers or the air. This is where the government or local authorities are used to control such issues. Other examples are extensive farming that destroys hedgerows and wildlife and the global warming caused by CO² emissions. A recent attempt to cut down these emissions in London is the introduction of congestion charges to prevent as many people driving into London and encourage them to take the train or other means of public transport to cut down emissions.
External benefits of production occur when the marginal social cost is less than the marginal private cost to the company (MSC<MC). For example if a company plants new woodland it benefits not only the company but the world due to a reduction of CO² in the atmosphere. Another example is that of research and development. If other firms have access to the results it benefits more than the company that finances it.
External costs of consumption (MSB<MB) is when the third party suffers from another’s consumption, for example when people suffer from the exhaust, fumes or noise from people using their cars. These ‘negative externalities’ make the marginal social benefit of people using their cars less than the marginal private benefit. The MSB curve is lower than the MB curve. Other examples include the negative effects a loud radio has in public places or the smoke from cigarettes and litter.
External benefits of consumption are when the marginal social benefit is greater than the marginal benefit (MSB>MB) For example, when more people travel on the train through congestion charges being brought in from the government other people benefit by there being less congestion and exhaust and fewer accidents would occur on the roads, therefore the marginal social benefit of rail travel is greater than the marginal private benefit to the rail passenger. There are external benefits outside the rail travel.
To summarise, when there are external benefits there will be too little produced or consumed. When there are external costs there will be too much consumed or produced.
There are many social benefits to the introduction of congestion charges. Firstly if more people travel by train it means less are travelling by car which will reduce CO² emissions. Worries about limitations in fossil fuel supply and the current worries about climate change have on the whole made the congestion charge receive a positive feedback and response. The amount of petrol being bought would reduce because less cars are needing it, which would save our much valued and fragile quantity of fossil fuels. It would mean that more people used public transport, more money would enter this trade which in turn would benefit consumers as money would be used to improve the state of trains and buses making the public transport system a more enjoyable experience, for example the introduction of air conditioning on tube trains.
Congestion charges force consumers to pay for the negative externalities that they create as a result of using their cars on a regular basis. It makes them conscious of the costs driving has not only on their bank account but upon the environment which over time may encourage them to chose a more environmentally friendly way to travel. When a good is supplied free of charge consumers tend to use more of it and in a more wasteful and thoughtless manner, previously the roads in and around London were supplied to consumers for free congestion charging is a basic economic concept where consumers are charged a price in order to allocate a scarce resource to its most valuable use, which becomes evident from the users willingness to pay for the resource.
Traffic is considered a negative externality; congestion charging is an efficient price strategy that has considerably reduced traffic, which has a positive effect on the third party citizen, an external benefit. Travellers now benefit from the charge by being able to get from A to B relatively easily without any time delays. In 2004 Ken Livingson announced that traffic had been cut by 18% and delays were down by 30% as a result of the charge.
Because there are fewer cars now on the roads accidents since the charges have been introduced have considerably decreased, showing another external benefit to society. Also, because the number of cars using the roads has considerably reduced you could suggest that less frequent investment into road servicing is needed the savings from this could fund more important faculties in life.
