Page 364 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Unit-24: Pigovian Welfare Economics and Externalities

Self Assessment Notes

Multiple choice questions:
4. When there is an increase in national income, there is an increase in ........................... .
(a) welfare (b) respect (c) non-welfare (d) none of these
5. To maximize the welfare ............................ is important for national income
(a) time (b) distribution (c) respect (d) variation
6. ............................ maximizes the welfare
(a) income (b) expense (c) economic equality (d) none of these
7. To understand the development of social welfare, Pigou adopts ............................ criterion.
(a) dual (b) general (c) economic (d) social
8. Pigou necessarily considers economic welfare and national income as ........................... .
(a) heaven (b) unnecessary (c) necessary (d) none of these

24.3 Analysis of Divergence between Private and Social Costs and
Returns, or of Externalities or External Effects

Amidst marginal personal and social expenses and benefits, deviation externalities or external effects or
external economies and diseconomies are known. “External effects” are assumed when the productivity
of a firm or utility of a person is dependent on such means that cannot be sold or bought; at least
currently such means are not exchangeable. External effects (between person and firms) are also known
as untraded interdependencies which can be mutual or uni-directional. External production leads to
production and production leads to consumption. This consumption can move toward production as
well. Externalities are positive and negative. Profitable externalities are known as positive externalities.
Expensive externalities are known as negative externalities. In other words, if personal gains are more
than social gains then these are positive externalities or external economies. Actually, externalities are
incomplete market, where market does not pay for the service or disservice of any commodity. Due to
these externalities, there is maldistribution of means because of which production or consumption is left
short of required level. Thus, because of external effects, maximum social welfare is not possible. Pigou
should be credited not only for analyzing the reasons for external effects but also for providing solutions
to remove the deviations due to social and personal expenses and benefits, which are described below.
Causes of divergences between social and private costs and returns—According to Pigou, free from
the restrictions of ignorance and rigidity, there is equality in personal and social expenses and results.
But some commercial behaviour give rise to rigidities by which changes are produced in personal and
social expenses which through changes, tastes, business highs and lows, war and new business become
more detailed. After obtaining external economies and diseconomies, there is difference in private
product and social product by which deviation is found in social and personal expenses and profits.
Now we will analyze these external economies and diseconomies.
1. External economies of production: When any firm without using the benefit and cost of any
service provides the benefit and cost of same service to some other firms, then this is the external
economies of production. Because of the lack of average cost of one or more firms, the external
economies of production are obtained by other firms for their activities. The external economies
of production are obtained when it becomes possible for one firm to obtain for other firms' trained
labour, raw material, etc. at low rate. Under all these conditions, social marginal profit is more
than the personal marginal profit and personal expenses are more than social expenses. This is
because the firms that do the transmission do not ask anything from other firms for the expenses
and benefits.

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