1.3.2 Externalities

Question 1

Define externalities

Answer 1

Costs and benefits that affect 3rd parties that are not directly involved in a transaction

Question 2

What are externalities?

Answer 2

Are a form of market failure, because market forces will not result in an efficient allocation of resources

Question 3

What are the types of externalities?

Answer 3

• External costs (negative externalities)

- External benefits (positive externalities)

Question 4

Define private costs

Answer 4

Costs that are paid directly by the producer and consumer in a transaction

Question 5

Private costs of a producer

Answer 5

Include:

• wages
• rent
• raw materials
• energy

Question 6

Private costs for a consumer

Answer 6

The cost to the consumer is usually the price paid for the product/service

Question 7

Define external costs

negative externalities

Answer 7

The costs in excess of private costs that affect 3rd parties who are not part of the transaction

Question 8

Examples of external costs of production

Answer 8

• Air pollution, e.g. noxious gases from a factory
• Noise pollution, e.g. from building work associated with a new factory or from machinery used in the production process
• Pollution arising from the destruction of the rain forest to grow crops

Question 9

Examples of external costs of consumption

Answer 9

• Passive smoking, i.e. a non-smoker might suffer from adverse health effects if he/she is in the presence of a smoker over a period of time
• Overeating by individuals: obesity might result in significant costs for the National Health Service and, in turn, taxpayers

Question 10

Define social costs

Answer 10

The sum of private costs and external costs

Private costs + External costs = Social costs

Question 11

Define private benefits

Answer 11

benefits that are received directly by the producer and consumer in a transaction

Question 12

Private benefits to a producer

Answer 12

Include

- revenues received from the sale of the product/service

Question 13

Private benefits to a consumer

Answer 13

The utility (satisfaction) gained by the consumer from the consumption of the product/service

Question 14

Define external benefits

positive externalities

Answer 14

The benefits in excess of private benefits which affects 3rd parties who are not part of the transaction

Question 15

Examples of external benefits of consumption

Answer 15

• Individuals deciding to have vaccinations preventing the spread of diseases to others
• Households with well-kept gardens increasing the market value of neighbouring properties

Question 16

Examples of external benefits of production

Answer 16

• A farmer who keeps bees to make honey. the bees will benefit surrounding farmers by pollinating their crops
• A firm trains workers in computing skills. Other firms that do not train workers might benefit from employing workers from this firm

Question 17

Define social benefits

Answer 17

The sum of private benefits and external benefits

Private benefits + External benefits = Social benefits