Externalities in consumption
These are externalities the flow purely from the consumption of a good or service. Whilst some externalities in consumption can be positive (such as education and gardening), most are negative.
Positive externalities in consumption
Goods with positive externalities in consumption result in social benefits that are not captured by a market. The goods are under-produced to the extent that the socially optimal level of production is not achieved. Education is a good example, where a market will only ensure that production takes place where the private benefits equate to the private costs. The additional benefits that accrue to society more generally once a person receives years of education are not taken into account because a private consumer will generally not be prepared to pay the additional price for a benefit they will not directly receive. Accordingly, the government intervenes by subsidising private schools or directly providing public education. This enables the production and consumption of education to take place closer to the 'socially optimal' level.
Negative externalities in consumption
Goods with negative externalities in consumption result in costs that are passed onto third parties or society more generally, such as passive smoking or excessive CO2 emissions that contributes to global warming. The goods are over-produced to the extent that the socially optimal level of production is not achieved. Again, this typically means that there is an over-allocation of resources to the production and consumption of those goods and services with negative externalities in consumption.
Examples include the external costs associated with the consumption of illicit drugs, alcohol, cigarettes, and some firearms. In a free market, consumption of these goods and services (sometimes referred to as de-merit goods) would be far greater than occurs currently. In other words, the market would tend to over-produce these goods and services for two main reasons.
Government action to reduce the problems associated with negative externalities in production or consumption can include: