Who pays for the smoke?
If buyers and sellers both gain, can a trade still make the wider community worse off?
A negative externality is a cost imposed on people outside the transaction that is not already included in the private cost. In this exercise, add that external damage to the resource cost before comparing one more unit’s benefit with its social cost.
Try the fictional case
A fictional workshop can make up to five batches per day. A batch creates $15 of assumed damage to neighbors. The figures below apply to each additional batch, not to all batches together. Ignore fixed costs, uncertainty, and other spillovers.
| Batch | Buyer benefit | Private cost | External damage |
|---|---|---|---|
| 1 | $50 | $10 | $15 |
| 2 | $40 | $15 | $15 |
| 3 | $30 | $20 | $15 |
| 4 | $20 | $25 | $15 |
| 5 | $10 | $30 | $15 |
- Calculate the social cost of the third batch. Compare it with its buyer benefit.
- Which batches have buyer benefits greater than their social costs? Add those batches’ net social benefits.
A simple 20 minute plan
Spend 4 minutes on the opening question, 8 on the table and calculations, 5 comparing explanations, and 3 on an exit ticket: “My conclusion is ____. One assumption that matters is ____.”
Open teacher answers
- The third batch’s social cost is $20 + $15 = $35. Its $30 benefit is $5 lower, so that batch reduces net social benefit by $5.
- The first two qualify. Their net benefits are $50 minus $25 = $25 and $40 minus $30 = $10. The total is $35 per day.
A tax receipt is not the same as pollution damage or an extra resource cost. Also, a spillover cost is not automatically equal to an amount a policymaker can observe accurately.
Teacher answer guide
- The third batch’s social cost is $20 + $15 = $35. Its $30 benefit is $5 lower, so that batch reduces net social benefit by $5.
- The first two qualify. Their net benefits are $50 minus $25 = $25 and $40 minus $30 = $10. The total is $35 per day.
A tax receipt is not the same as pollution damage or an extra resource cost. Also, a spillover cost is not automatically equal to an amount a policymaker can observe accurately.
State the limit
The table assumes exact, constant damage per batch and fully known buyer benefits. It cannot select a real tax rate, quantify actual health damage, or settle how costs should be distributed.
Further reading: OpenStax: the economics of pollution. Activities and examples are original to World Economy. A reference does not imply endorsement.
Want the complete teaching sequence?
The $19 Markets & Society Teaching Pack adds three 45 minute plans, longer student worksheets, worked extensions, case cards, an assessment, and a rubric. One teacher and one cohort of up to 30 learners.
See the pack and free sample →World Economy · losttofound.org/classroom/externalities. An adult educator may print or privately share this free starter with their own learners. Keep the source attached. No resale or public rehosting. The paid pack has separate license terms.