Econ Lab · Markets
Negative externalities
The coffee roaster down the street smells wonderful from the cafe and awful from the flats next door. The roaster pays for beans and gas. It does not pay for the smoke. Someone else does, and that gap quietly tilts how much coffee gets made.
Slide the external cost up and watch the town's best amount pull away from what the market actually brews.
A roaster pays for beans, gas, and labour. It does not pay for the smoke it sends over the fence. So the cost it weighs up is lower than the cost the town actually bears.
The smoke adds dollars of harm to every cup, a cost the roaster never sees on its bill. It keeps brewing as long as a buyer values a cup above its private cost, so it runs out to cups when is what the town would pick. The overshoot is modest here. The shaded triangle is small because the cups past the optimum still carry only a little hidden harm each.
The fix is to make the roaster feel the smoke. A tax of dollars a cup lifts private cost up onto social cost, so the roaster now stops brewing exactly at cups and the triangle closes.
Drag the slider to set the harm per cup. The dashed line is the cost the whole town bears, and the shaded triangle is the waste.
Two costs, not one
The roaster only counts what it pays: the private marginal cost. The town counts that plus the smoke. Add the harm per cup and you get the social marginal cost.
When the harm is real, the social cost line sits above the private one by exactly the harm per cup. That whole gap is paid by neighbours who never bought a coffee.
The market aims at the wrong line
A market settles where benefit meets the cost the seller feels. That is the private cost, so the roaster brews two hundred cups. The town would rather stop where benefit meets the full social cost, which is fewer cups. Every cup in between costs the town more than it is worth.
The triangle is the waste
The shaded triangle is the deadweight loss. It is the harm stacked up over all the cups the market makes past the town's best point. Push the external cost higher and the optimum slides further left, so the triangle grows. Set the harm to zero and it vanishes, because then private and social cost are the same thing.
How a tax fixes it
Charge the roaster a tax equal to the harm per cup. Now the roaster pays the smoke as if it were a bean cost, and its private cost rises right onto the social cost line. It chooses the town's best amount on its own, not from goodwill but because the price finally tells the truth.