1.3.2 Externalities

Question 1

What is an externality

Answer 1

Spill-over effects from production and/or consumption for which no appropriate compensation is paid to third parties effected

Question 2

Why do externalities lead to market failure

And what type of market failure do it lead to

Answer 2

externalities lie outside initial market transaction and not reflected in market price

Meaning price mechanism doesn’t take into account full social costs and benefits of production/consumption

Partial market failure

Question 3

Externalities can be either:

Answer 3

Positive or Negative

Question 4

Private Costs are

Answer 4

costs faced by the produer/consumer directly involved in a transaction

Question 5

External Costs

Answer 5

are the costs imposed on third parties as a result of a transaction that they are not directly involved in

synonym for externalities

Question 6

Social Costs =

Answer 6

Private Costs + External Costs

Question 7

Negative Externalities exits when

Answer 7

Social Costs exceed private costs

Question 8

How does negative externalities link to price and quantity consumed/produced

Answer 8

Price needs to be higher

Quantity conusmed/produced needs to be lower

Question 9

What is Marginal private costs

Answer 9

cost to the producing firm of producing addtional units of output or

costs to an individual of any economic action

Question 10

Marginal external Cost

Answer 10

costs to third parties from the production of an additional unit of output

Question 11

Marginal Social Costs

Answer 11

Total cost to society of producing an extra unit of output

Question 12

What two things added together form Marginal Social Costs

(MSC)

Answer 12

MPC + MEC

Marginal Private Costs + Marginal External Cost

Question 13

Give examples of negative externalities from production

Answer 13

Air Pollution

Pollution from fertilizers

Industrial waste

Nosie pollution

Collapsing fish stock

Methane emission

Question 14

Describe the graph for Negative Externalities

Answer 14

• Two Supply curves (MSC and MPC) which aren’t parallel to another due to MSC needing higher price and lower output
• Where MSC=MPB is the Socially Optimum point
• Where MPC=MPB there is an allocative inefficiency
• The distance between the equilibrium of MPC=MPB and MSC is the Welfair loss

Question 15

What is a (deadweight) welfare loss

Answer 15

refers to the toal value of the undesired impact of negative externalities, as a result of over production

(Prices are too low and consumption is too high)

Question 16

What is a positive externalities

Answer 16

exits when third parties benefit from the spill-over effect from production/consumption

Social benefits exceeds private benefits

Question 17

Private Benefits

Answer 17

benefits faced by the producer or consumer directly involved in a transaction

Question 18

External Benefits

Answer 18

Benefits enjoyed by third parties as a result of a transaction that they are not directly involved in

(synonym of postive externalities)

Question 19

Social Benefit =

Answer 19

Private Benefit + External Benefits

Question 20

How do Positive externalities link to price and quantity consumed/produced

Answer 20

Consumption/Production is too low

Market price is too high/ however more money should be allocated to them because consumers are unaware of importants

Question 21

What is Marginal Private Benefit (MPB)

Answer 21

Benefits to the consumers of consuming an additional unit of output

Question 22

Marginal external Benefit (MEB)

Answer 22

Benefit to third paties from consumption of an addition unit of output

Question 23

Marginal Social Benefit (MSB)

Answer 23

Total benefit to society of consuming an extra unit of output

Question 24

What two things add together to total Marginal Social Benefit (MSB)

Answer 24

MSB = MPB + MEB

Marginal Private Benefit + Marginal External Benefit

Question 25

With Positive (consumption) externalities, is marginal social benefit lower than Marginal private benefit

Answer 25

No

Marginal Social benefit is higher

Question 26

Describe the graph for positive externalities of consumption

Answer 26

• The demand lines for MPB and MSC aren’t parallel because Price needs to be higher and quantiy consumed/produced is higher (due to under consumption)
• Socially optimum point = MSB=MPC
• The Social welfare loss is the distance between where MPB=MPC and MSB

Question 27

Give examples of postive conusmption externalities

Answer 27

Healthcare programmes

Early years education

Subsidised Bike Schemes

Public Libaries

Museums + Galleries

Free School meal/ nutrional advice