Consumption externality

Definition consumption externality

This occurs when consuming a good cause either a positive or negative externality to a third party.

Positive consumption externality

When consuming a good gives a benefit to others. Examples include:

  • Going to university. Your education gives benefit to rest of society (You can teach others)
  • Taking medicine which prevents spread of infectious disease.

Diagram of positive consumption externality


Because there is a benefit to others from your consumption, the social marginal benefit (SMB) is greater than private marginal benefit (PMB)

In a free market, there will be under-consumption of goods with positive consumption externalities.

Output in a free market will be at Q1, but social efficiency is at Q2 (where SMC = SMB)

Negative consumption externality

Consuming a good causes a harmful effect on third parties.


In this case, there will be over-consumption of goods with negative consumption externalities in a free market.

Example of negative externality in consumption

  • e.g. smoking causes harmful effect to those who breathe in your smoke.


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