1.3.2 - Externalities Flashcards
Define external cost
a cost to a third party that is not involved in the making, buying/selling and consumption of a specific good/service
- negative externality
Define external benefit
a benefit to a third party that is not involved in the making, buying/selling and consumption of a specific good/service
- positive externality
Define Private cost
Private costs are the costs to the individual participating in the economic
activity
Define private benefit
Private benefits are the benefits to the individual participating in the economic
activity
What is social benefit
external benefit + private benefit
What is social cost
external cost + private cost
When does market failure occur
in the free market, price mechanism only takes into account the private costs and benefits but no the extrnal costs and benefits
On externality diagrams what are demand and supply curves changed to
Supply = marginal cost
Demand = marginal benefit (bc law of diminishing marginal utlility explains downward sloping demand curve - as consumption rises, utility falls and as price rises, demand falls)
What happens when MPC and MSC are parallel or they diverge
Parallel - external costs per unit is constant, diverges - external cost per unit rises
What happens when MPC and MSC are parallel or they diverge
Parallel - external costs per unit is constant, diverges - external cost per unit rises
When does equilibrium occur
When MPC = MPB but this is allocatively inefficient and leads to market failure as external cost and benefits ignored
What is the socially optimal level of output
When the level of output and price will give society the maximum benefit of any positive externalities and still cover the cost of negative externalities
