1.3.2

Question 1

What are externalities?

Answer 1

Spill-over effects from production/consumption for which no appropriate compensation is paid to one or more third parties affected.

Question 2

Externalities are impacts on?

Answer 2

‘Third parties’ as a result of a market transaction

Question 3

Why are externalities not reflected in the market price?

Answer 3

They lie outside the initial market transaction

Question 4

How do externalities cause market failure?

Answer 4

If the price mechanism does not take account of the full social costs and benefits of production and consumption

Question 5

What are private costs?

Answer 5

The costs faced by the producer or consumer directly involved in a transaction

Question 6

What are external costs?

Answer 6

The costs imposed on third parties as a result of a transaction that they are directly involved in

Question 7

What is the equation for social costs?

Answer 7

Social costs = private costs + external costs

Question 8

When negative production externalities exist what dies this mean for social costs?

Answer 8

Social costs exceed private costs

Question 9

How do external costs damage third parties?

Answer 9

The consumer and producer don’t have to pay, output will be too high, the market price will be too low.

Question 10

What are examples of negative externalities from production?

Answer 10

-Air pollution from factories
-Pollution from fertilisers
-Industrial waste
-Noise pollution
-Collapsing fish stock
-Methane emissions

Question 11

What are the ways economists believe that externalities can be valued?

Answer 11

Shadow pricing
Compensation
Revealed preference

Question 12

Marginal private cost(MPC)?

Answer 12

Cost to the producing firm of producing an additional unit of output to an individual of an economic action

Question 13

Marginal external cost (MEC)?

Answer 13

Cost to third parties from the producing of an additional unit of output

Question 14

Marginal social cost (MSC)?

Answer 14

Total cost to society of producing an extra unit of output

Question 15

What is the equation for marginal social cost?

Answer 15

Marginal private cost + marginal external cost

Question 16

When do positive externalities exist?

Answer 16

When third parties benefit from the spill-over effects of production/cosnumption.

Question 17

What is an example of a positive externality?

Answer 17

The social returns from investment in training

Question 18

What is a private benefit?

Answer 18

The benefits faces by the producer or consumer directly involved in a transaction.

Question 19

What are external benefits?

Answer 19

The benefits enjoyed by third parties as a result of a transaction that they are not directly involved on

Question 20

What is the equation for social benefit?

Answer 20

Social benefits = private benefit + external benefit

Question 21

When positive (consumption) externalities exist what happens to social benefit?

Answer 21

Social benefits exceed private benefits

Question 22

Why are external benefits good for third parties?

Answer 22

The consumer and produced don’t take this into account, meaning that output will be too low. The market price will be too high.

Question 23

Marginal private benefit (MPB)?

Answer 23

The benefit to the consumer of consuming an additional unit of output

Question 24

Marginal external benefit (MEB)?

Answer 24

Benefit to third parties from the consumption of an additional unit of output

Question 25

Marginal social benefit (MSB)?

Answer 25

Total benefit to society of consuming an extra unit of output.

Question 26

What is the equation for marginal social benefit?

Answer 26

Marginal social benefit = marginal private benefit + marginal external benefit