1.3.1 Externalities Flashcards
What is meant by market failure
Market failure is when the free market leads to an insufficient allocation of resources
What is meant by an externality and give an example
When the consumption of a good has a third party effect i.e. smoking a cigarette
Define negative externalities
Negative externalities are when the consumption/production of a good has a negative effect on the third party.
Define positive externalities
Positive externalities are when there is a benefit to the third party in a transaction
Define private costs
Private costs are ones that affect the buyer or seller in the transaction
Give 3 examples of private costs in the production of a pencil
The people who are paid for the raw materials: The producer of wood, the producer of rubber, the producer of graphite
Define external costs
External costs are costs that effect the third party in the transaction.
Give 2 examples of external costs in the production of a pencil
The wildlife affected in the deforestation to obtain the wood.
Transporting these goods will cause pollution that affect people and animals.
Define social costs
Private costs + External costs
Define social benefits
Private benefits + External benefits
Define and give examples of a merit good
A merit good is a good that has a positive externality in consumption.
- Vaccines
- Free school meals
Define and give an example of a demerit good
A demerit good is one that has a negative externality in consumption.
- Alcohol
- Cigarettes
Define and give examples of a private good
Private goods are provided by the free market and are used by businesses to purchase satisfaction and utility.
- Clothes
- Flowers
In what way are externalities a case of market failure
Externalities mean that free market equilibrium is different from the socially optimum equilibrium. This difference in equilibrium means that some goods are over/under produced meaning that some resources are used inefficiently and aren’t allocated appropriately leading to market failure.
