1.3.2 - Externalities

Question 1

Define Externality

Answer 1

. The cost or benefit a third party receives from an economic transaction outside of the market mechanism

. Externalities arise when private costs and benefits are different from social costs and benefits

Question 2

. Name the three types of costs

Answer 2

. Private costs
. External costs
. Social costs

Question 3

Define Private Costs

Answer 3

the cost of an activity to an individual economic unit, such as a consumer or firm

e.g. a company will have to pay for workers, raw materials and machinery when it produces chemicals

Question 4

Define External Costs / Negative Externality

Answer 4

the costs caused by externalities

. There is negative externality when net social cost is greater than net private cost.

E.g. The chemical manufacturer produces pollution to the environment

Question 5

Define Social Costs

Answer 5

. cost of an activity to society as a whole

. Adding private cost to the external cost gives the social cost

E.g The chemical manufacturer has to pay his staff (private cost). He also releases chemicals to the environment (external cost)

Question 6

Define Production Externalities

Answer 6

. When social costs of production are different from the private costs of production

Question 7

Name two types of Production Externalities

Answer 7

. Negative production externalities

. Positive production externalities

Question 8

Define negative production externalities

Answer 8

. costs to third parties as a result of the actions of producers

. When social costs are greater than private costs in production

. Means that there is over production of goods

. This is market failure

E.g. When a factory pumps sewage into a river at no cost to itself

Question 9

Define positive production externalities

Answer 9

. benefits to third parties as a result of the actions of producers

. Means there is under production of goods

. When social costs are less than private costs in production

. This is market failure

E.g. A supermarket redeveloped which redeveloped a derelict industrial site for a new store, but at the same time cleaned up pollution, improved roads and funded construction of housing near the site

E.g. Producers may be offering high quality training. The third party that benefits from this are other firms who able to poach workers who have done training, without having to pay the cost of training, which saves money

Question 10

Define Consumption Externalities

Answer 10

. When the social benefits of consumption differ from the private benefits of consumption

Question 11

Name two types of Consumption Externalities

Answer 11

. Positive consumption Externalities

. Negative consumption Externalities

Question 12

Define Positive Consumption Externalities

Answer 12

. benefits to third parties as a result of the actions of consumers

. Occurs when social benefits are greater than private benefits in consumption

. Means there is under consumption of goods

. This is market failure

E.g. Healthcare - A individual vaccinated can benefit other third parties as they have a smaller chance of flu

E.g. Education - If a person gets educated, the greater the tax revenue

E.g. Exercise - Healthy workers will be more productive for workers

Question 13

Define Negative Consumption Externalities

Answer 13

. costs to third parties as a result of the actions of consumers

. Occurs when social benefits are less than private benefits in consumption

. Means there is over consumption of goods

. This is market failure

E.g. With passive smoking, a person that smokes in their home harms the health of others in the home

E.g Gambling addiction affecting family

E.g. Noise pollution from events

Question 14

Define External Benefit / Positive Externality

Answer 14

. Benefits caused by externalities

. If net social benefit is greater than net private benefit, a positive externality exists

E.g. A company may build a nice - looking that is not functional . The value of pleasure that the building gives to society (social benefit) exceeds the benefit of the building received by the company (private benefit).

E.g. An individual may benefit from treatment from a communicable disease (private benefit). However, the rest of the public also benefits from reduced chance of disease (social benefit). Social benefit is greater than private benefit resulting in positive externality

Question 15

Define Private Benefit

Answer 15

. The benefit of an activity to an individual economic unit such as a consumer or firm

Question 16

Define social benefit

Answer 16

. Adding private benefit to the external benefit gives the social benefit

. It its the full benefit received by society of a good or service

Question 17

Name three types of Benefits

Answer 17

. Private Benefit
. Social Benefit
. External Benefits

Question 18

Define marginal social / private cost / benefits

Answer 18

the social costs and private costs and benefits of the last unit either produced or consumed

Question 19

Why do all externalities lead to market failure?

Answer 19

. Externalities lead to market failure, as a product’s good or service does not accurately reflect the true costs and benefits of that product or service

. Additionally, the producer or consumer does not care about the social cost / benefits in a free market

. There is also either overproduction, overconsumption, underproduction, underconsumption depending on the type of externality.

Question 20

Define allocative efficiency

Answer 20

. Means there is an optimal distribution of goods and services at a certain price

Question 21

Define allocative inefficiency

Answer 21

. Means that there is not an optimal distribution of goods and services at a certain price

Question 22

Define Demerit Good

Answer 22

.A good that has damaging effects on the consumer. It has a negative externality.

. They are over - consumed and over - produced by the free market due to information failure and negative externalities that arise from their consumption.

E.g. Alcohol, cigarettes, drugs, gambling

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Question 23

Define Merit Good

Answer 23

. Merit Goods are more beneficial to individual consumers that they realise

. They are under consumed and under provided by the free market due to information failure and positive externalities that rise

Examples : Museums, healthy food, sun cream, vaccinations

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