Basic Concepts

Abstract

Abstract Neoclassical economists view environmental disruption as a problem of negative externalities. A negative externality occurs whenever an agent has to bear a part of the cost of another agent’s activity without being compensated. The agent causing the externality does not take this into account. She bears only the private costs of the activity. The social costs, i.e. the total costs that are borne by society, exceed the private costs. Since a part of the social costs is external and does not enter the agent’s optimization calculus, too much of the activity is performed. Too much pollution is generated and environmental disruption exceeds its socially acceptable level. This is illustrated by Figure 1.1 where a market of a commodity is considered whose production causes environmental damage. Thus, the social costs exceed the private costs of production. Let pand qdenote the price and quantity of the commodity under consideration, and let Dbe the demand curve. The private and social supply of the good are given by the private and social marginal cost curves, PMC and SMCThe social marginal cost exceeds the private marginal cost since damages that accrue to the rest of society are not taken into account by the individual supplier.