1.3.2 Negative Externalities

Question 1

What are negative externalities ?

Answer 1

These are costs which affect third parties outside the price mechanism

Question 2

What does taxing goods like cigarettes, alcohol and fossil fuels do ?

Answer 2

The government makes it more expensive for consumers to buy the good and producers to sell the good. This will discourage the use of those goods and protect society from harmful third party effects

Question 3

If Bob started smoking cigarettes, would anyone else be affected as well as Bob ?

Answer 3

You affect the rest of society through passive smoking. These people are outside the price mechanism and are not involved in the transaction.

Question 4

What type of negative externality is caused from Bob smoking ? And why ?

Answer 4

This is called negative consumption externalities. This is because it is Bob’s consumption is causing these negative externalities.

Question 5

What is the definition of negative consumption externality ?

Answer 5

These are costs which affect third parties not involved in the transaction as a result of the consumption of the good.

Question 6

What are other examples of negative consumption externalities and how is it ?

Answer 6

Alcohol can be one as when consumers consume too much alcohol they tend to throw up on roads, get into fights with others or vandalise property.

Another example can be Cars as when consumers drive around cars, they burn fossil fuels which damages the environment for the rest of us. They could also get into accidents and injure innocent pedestrians and other drivers

Question 7

What type of negative externality is caused from producers for example who produce woolly jumpers and why ?

Answer 7

Producers who produce woolly jumpers may use harmful chemicals in order to add colour to the jumper. This may pollute the nearby park rivers which poison the local population of brown beavers. This may have a huge cost to the park owner. The park owner had nothing to do with the price mechanism and was still negatively affected when producers produced the woolly jumpers. This is called a negative production externality as the negative externality is caused from the producers production of woolly jumpers.

Question 8

What are other examples of negative production externalities ?

Answer 8

Buildings can be one as when producers construct new buildings or houses, these may cause noise pollution to nearby residents. The transport vehicles which hold materials for production may block roads affecting other drivers. The fossil fuels they use to power their machinery can contribute to global warming negatively affecting society.

Question 9

Inside the price mechanism, what is there ?

Answer 9

Private costs and private benefits.

Question 10

Outside the price mechanism, what is there ?

Answer 10

External costs and external benefits

Question 11

What do producers care most and least about when producing their goods ?

Answer 11

They care most about their private costs and less about the external costs caused from producing these goods.

Question 12

What do producers have when they are producing a good and what do consumers have when they buy the product ?

Answer 12

Producers have private benefits and consumers have private costs. They are also inside the price mechanism.

Question 13

What are the type of costs which is incured by society who is outside the price mechanism ?

Answer 13

External costs

Question 14

Why does marginal cost really mean marginal private cost and why does marginal benefit really mean marginal private benefit ?

Answer 14

MC really means MPC as these costs are experienced by the supplier. MB really means MPB as we talk about the consumers benefit of consuming that good. They are both inside the price mechanism

Question 15

What does the government think about when they are reviewing negative productive externalities ?

Answer 15

They care about societies cost known as social cost and benefit known as social benefit

Question 16

What is the formula for social cost ?

Answer 16

Private cost + external costs. You need to add all the costs which are experienced by society

Question 17

What is the formula for social benefit ? What are the exceptions in negative productive externalities ?

Answer 17

Private benefit + external benefit. In some cases there are no external benefits at all. Therefore social benefit can equal to private benefit

Question 18

In the negative productive externality diagram, what does both demand and supply curve equal to ?

Answer 18

The demand curve is equal to MPB and MSB and the supply curve is equal to the marginal private cost.

Question 19

How do you draw the marginal social cost curve ? And what does this vertical distance between the MSC and MPC represent

Answer 19

The MSC curve is vertically higher than the MPC curve. The vertical distance represents the external costs added on from the MPC line.

Question 20

What does the marginal cost and benefit show ?

Answer 20

MC shows the lowest price producers will be willing to sell their good for. MB shows the highest price consumers are willing to pay for the good

Question 21

What is net benefit and how do you work it out ?

Answer 21

It is an absolute measure of benefits. You work it out by subtracting the social benefit by the social cost

Question 22

Where is the socially efficient equilibrium ?

Answer 22

This is when net benefit is equal to 0. Where MSB=MSC

Question 23

Where is the welfare loss ? How do you draw it ?

Answer 23

Any point after the socially efficient equilibrium to the market equilibrium point. To draw it you move up from the equilibrium point and shade in the triangle.

Question 24

What is it called from the socially efficient equilibrium to the original market equilibrium ?

Answer 24

It is called an overproduction

Question 25

Why do producers continue even after there is negative net benefit ?

Answer 25

They do not care about the external costs. They only care about the private costs which is experienced by them. Consumers care about their own private benefits. Therefore they produce where MPC=MPB

Question 26

How do you draw the MSC curve ?

Answer 26

You have to add the external cost towards the MPC, shifting vertically upwards.

Question 27

What is consumers demand and suppliers supply based on ?

Answer 27

Suppliers supply is based on MPC while consumers demand is based on MPB from consumption

Question 28

What is the difference between the two types of negative production externality diagrams ?

Answer 28

The difference external cost stays the same for one and external cost increasing for the other as quantity increases for both

Question 29

What happens to the negative production externality when an indirect tax is set ?

Answer 29

The externality will become internalised

Question 30

What does it mean if the MSC is higher than the MPC ?

Answer 30

The external cost is positive and results in a negative externality

Question 31

What is a demerit good ?

Answer 31

It is a good or service whose consumption causes external costs and is considered to be over consumed