1.3.2 Using Diagrams to Illustrate Externalities

Question 1

define marginal private costs

Answer 1

the cost to a firm of producing/suppling an extra unit of output or the cost to an individual of any economic action/decision

Question 2

define marginal external costs

Answer 2

costs to third parties from the production/consumption of an extra unit of output

Question 3

define marginal social costs

Answer 3

total cost to society arising from producing/consuming an extra unit of output

Question 4

what is the formula for marginal social costs

Answer 4

MSC=MPC+MEC

Question 5

define marginal private benefits

Answer 5

the benefits to a firm of producing/supplying an extra unit of output, or the benefits to an individual of any economic decision

Question 6

define marginal external benefits

Answer 6

benefits to third parties from the production/consumption of an extra unit of output

Question 7

define marginal social benefits

Answer 7

total benefit to society arising from producing/consuming an extra unit of output

Question 8

what is the formula for marginal social benefits

Answer 8

MSB=MPB+MEB

Question 9

how can you draw positive externalities using cost and benefit curve diagrams

Answer 9

• draw MPC (supply) and MPB (demand) equilibrium
• shift MPB outwards to form the MSB curve. this causes the marginal social benefit of consumption to be higher than the marginal private benefit

Question 10

what is the marginal external benefit shown by on a diagram

Answer 10

the vertical difference between MSB and MPB

Question 11

what does Q2 show

Answer 11

social efficiency as the social cost=social benefit. if we stay at Q1, there is underconsumption, and this causes market failure

Question 12

how can we show social welfare loss arising from positive consumption externalities

Answer 12

triangle ABC (society would prefer Q2 whereas free market equilibrium (ignores externalities) is as Q1

Question 13

what interventions might be used to address market failures from positive externalities

Answer 13

• behavioural nudges
• government provision
• subsidies
• mandatory choices

Question 14

what is the private optimum level of output

Answer 14

where the marginal private benefit is equal to the marginal private cost

Question 15

what is the social optimum level of output when there are negative externalities

Answer 15

takes externalities into account, so MSC=MSB

Question 16

what is the marginal external cost shown by on a diagram

Answer 16

vertical difference between MSC and MPB

Question 17

why do we say that negative externalities lead to market failure

Answer 17

output Q1 only considers private costs and benefits, if we ignore the externalities, output is too high for a social optimum (Q2) (overproduction)

Question 18

how can you draw negative externalities using cost and benefit curve diagrams

Answer 18

• draw MPC (supply) and MPB (demand) equilibrium
• shift MPC inwards to form the MSC curve. this causes the marginal social cost of consumption to be greater than the marginal private cost

Question 19

how can we show social welfare loss arising from negative consumption externalities

Answer 19

the deadweight welfare loss arising from overproduction is triangle ABC (society would prefer Q2 whereas free market equilibrium (ignores externalities) is as Q1