1.3 - Externalities

Question 1

Private costs

Answer 1

The costs incurred by producers or consumers directly involved in a transaction or economic activity
> costs are borne by the parties directly engaged in the production or consumption of a good or service

Question 2

External costs

Answer 2

Costs imposed on third parties who are not part of the transaction or activity.
> these costs are not considered by the parties directly involved and are often detrimental to society

Question 3

Social costs

Answer 3

Represent the total costs of an economic activity, including both private costs and external costs.
> They reflect the overall impact of an activity on society, accounting for both direct and indirect costs.

Question 4

Private benefits

Answer 4

Refer to the benefits received by producers or consumers directly involved in a transaction or economic activity.
> These benefits are enjoyed by the parties directly engaged in the production or consumption of a good or service.

Question 5

External benefits

Answer 5

Benefits received by third parties who are not part of the transaction or activity.
> These benefits are often beneficial to society but are not considered by the parties directly involved.

Question 6

Social benefits

Answer 6

• Represent the total benefits of an economic activity, including both private benefits and external benefits.
  > They reflect the overall positive impact of an activity on society, accounting for both direct and indirect benefits.

Question 7

Negative externalities of production…

Answer 7

• Negative externalities of production are often created during the production of a good/service
• The market is failing due to over-provision of these (often demerit) goods/services as only the private costs are considered by the producers and not the external costs
• If the external costs were considered, the quantity of the goods/services provided would decrease and they would be sold at a higher price

Question 8

Positive externalities of consumption…

Answer 8

• Positive externalities of consumption are created during the consumption of a good/service (merit goods)
• The market is failing due to under-consumption of these goods/services as only the private benefits are considered by the consumers and not the external benefits
• If the external benefits were considered, the quantity of the goods/services consumed would increase and they would be sold at a higher price

Question 9

Marginal private cost (MPC)

Answer 9

The cost of the next unit produced or consumed

Question 10

Marginal private benefit (MPB)

Answer 10

The benefit derived from the production or consumption of the next unit

Question 11

Impact on economic agents of negative externalities

Answer 11

• Producers may not fully account for external costs, leading to overproduction of goods with negative externalities.
• Consumers may not fully consider external costs, leading to overconsumption.
• Overall, negative externalities can result in market inefficiencies and reduced social welfare.

Question 12

Impact on economic agents of positive externalities

Answer 12

• Producers may not capture all external benefits, leading to underproduction of goods with positive externalities.
• Consumers may not fully appreciate external benefits, leading to underconsumption.
• Overall, positive externalities can result in underallocation of resources to beneficial activities.

Question 13

What can correct externalities

Answer 13

• Government intervention can correct externalities

Question 14

How can taxes correct negative externalities?

Answer 14

Internalise external costs, reducing overproduction, moving production closer to the social optimum position.

Question 15

Subsidies on positive externalities

Answer 15

Internalise the externality by lowering production costs, encourages greater provision of beneficial goods and services.

Question 16

Other methods of government intervention to correct externalities (not including taxes and subsidies)

Answer 16

1) Tradable pollution permits:
These allow firms to produce up to a certain amount of
pollution, and can be traded amongst firms so give them choice whilst reducing the
total level of pollution.

2) Provision of the good: When social benefits are very high, the government may decide to provide the good through taxation. They do this with healthcare and
education.

3) Provision of information:
Since some externalities are associated with information gaps, the government can provide information to help people make informed
decisions and acknowledge external costs.

4) Regulation:
This could limit consumption of goods with negative externalities