Negative Externalities of Consumption

The link between the consumption of tobacco products like cigars and heart / lung disease is indisputable. When individuals smoke cigars, they are compromising their own health and the health of those around them who inhale the smoke. Therefore, smoking is (unfortunately) an excellent example of a negative externality of consumption.

In a free market, consumers as utility-maximizers will consume cigars where their marginal private benefit equals marginal social cost (= S). They do not have to consider the cost of their consumption of cigars on the rest of the community through smoking-related illness and increased public health care receipts. If social efficiency were occurring, the market would be in equilibrium at a quantity level Q* as opposed to the greater Q1. Instead, there is a welfare loss (red triangles) since between Q1 and Q*, MSC > MSB and the market is thus not Pareto optimal. We observe a negative externality of consumption between MPB and MSB (purple arrow).


To address this market failure of a negative externality of consumption of cigars, the government could take several courses of action. First, they could place a tax on cigars in order to increase their price which would drive down the quantity sold and consumed. This is shown above by the broken blue line which corresponds to a return to the socially optimal level of output Q* and a higher price of P2. The government could then use this tax revenue to alleviate stress on the health care system from smoking-related illnesses. Of course, there will be debate on how to spend such money, to what extent smokers have the right to smoke and to what means smokers who face inelastic demand for tobacco products will go to procure cheaper product.

Second, the government could implement a negative ad campaign featuring anti-smoking commercials on television / radio and graphic posters of smoking-related illness on billboards along motorways and in written press. The aim of such an ad campaign would be to reduce smokers' private benefit from smoking by reducing their utility of tobacco consumption. After all, does looking at a black, diseased lung make you feel eager or happy to light up another smoke? This is illustrated above by the horizontal blue arrow and a leftward shift of the MPB curve towards MSB (and, thus, Q* which is socially efficient). However, such a campaign costs (taxpayer) money so the opportunity cost argument will be in play.

Otherwise, the government could simply ban tobacco products. But how would that affect stakeholders in the economy?