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Externalities of smoking

A perfectly competitive economy allocates resources optimally when price equals marginal cost in all lines of production. This is only possible when all costs and benefits fall upon the consumers and producers involved in an economic transaction. Otherwise externalities occur i.e. the parties involved in a transaction fail to recognise the costs and benefits to other members of society. Externalities are in fact a form of market failures and are also known as third party effects because parties other than the primary participants in the transaction are affected. Externalities create a divergence between private costs and benefits of an economic activity and social costs and benefits.

Externalities can be either positive or negative. A positive externality occurs, for instance, when the risk of an epidemic throughout society is reduced as an individual gets vaccinated. The present case will concentrate on the negative externalities arising as a result of an individual deciding to smoke cigarettes.

The private cost of smoking on an individual is the potentially harmful effects to the health of the latter. Elaborate on these effects.

Negative externalities occur since the social cost of an individual smoking exceeds the private cost. There are two obvious sources of negative externalities arising from smoking cigarettes: passive smoking and the extra burden on healthcare budget.

Elaborate on passive smoking - show how the rest of society is harmed by society.

Elaborate on the extra burden on healthcare budget

The graph illustrates the production of cigarettes. and are respectively the marginal social cost and the marginal private cost. The amount by which marginal social cost exceeds marginal private cost represents the external cost that the rest of society bears. The socially optimal output in this case is where the marginal social cost is equal to the price. However the output actually produced is . Therefore due to negative externalities the production actually involves a social loss.

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