1.3.2 - Externalities

Question 1

What Happens At Free Market Equilibrium?

Answer 1

There is efficient allocation of scarce resources.

Question 2

Describe Private Costs (PC)
(2 Points)

Answer 2

~ Costs of production for a producer.

~ MPC -> Marginal private cost, extra cost when producing one more unit.

Question 3

Describe External Costs (EC)

Answer 3

Costs to 3rd parties, people who are not involved in the economic activity.

Question 4

Describe Social Costs (SC)
(2 Points)

Answer 4

~ PC + EC = SC.

~ In a free market which is being AE, we assume that there are not EC, which is why S = MPC = MSC.

Question 5

Describe Private Benefits (PB)
(2 Points)

Answer 5

~ Individual consumer benefits, when consumers are consuming something.

~ MPB -> Marginal private benefit, extra benefit consumers get when they consume one more unit.

Question 6

Describe External Benefits (EB)

Answer 6

Any impact on 3rd parties as a result of consumption.

Question 7

Describe Social Benefits (SB)
(2 Points)

Answer 7

~ PB + EB = SB.

~ In a free market which is being AE, we assume that there are no externalities in consumption, which is why D = MPB = MSB.

Question 8

What Occurs When MSC = MSB?

Answer 8

Social optimum.

Question 9

What Occurs When MPC = MPB?

Answer 9

Private optimum.

Question 10

What Can We See If AE Is Occurring?
(3 Points)

Answer 10

~ Maximisation of society surplus, where CS + PS are the greatest they can be.

~ Maximisation of net social benefit, where MSB = MSC assuming there are no EB/C. Any point beyond Q* social costs will be higher than social benefit.

~ Where resources perfectly follow consumer demand, no surplus or shortages, no excess supply or demand.

Question 11

What Are Assumptions We Make With AE?
(5 Points)

Answer 11

~ Many buyers and sellers.

~ Perfect information.

~ No barrier to entry.

~ Firms profit max.

~ Consumers utility max.