4.1.8.4 positive and negative externalities in consumption and production

Question 1

what are externalities?

Answer 1

• the spillover effect on a third party, such that private costs and benefits will differ from the total social costs and benefits
  (which include the private and the external spillover)

Question 2

what are positive externalities?

Answer 2

positive production / consumption externalities

• caused by merit goods
• associated with info failure too because consumers don’t realise the long run benefits of the consumption
• they’re under-provided in the free market

Question 3

what are negative externalities?

Answer 3

negative production / consumption externalities

• caused by demerit goods
• associated with info failure, since consumers aren’t aware of the long run implications of consuming the good
• usually over-provided

Question 4

what’s the difference between a production and consumption externality?

Answer 4

production
- affect the supply curve
- producers = supply curve

consumption
- affect the demand curve
- consumers = demand curve

Question 5

why’s it difficult to determine the monetary value of an externality?

Answer 5

the extent to which the market fails involves a value judgement and therefore it’s hard to determine what the monetary value of an externality is

eg) hard to decide what the cost of pollution to society is different individuals put a different value on it thus making determine government policies difficult too

Question 6

what is the marginal social benefit?

Answer 6

MSB = marginal private benefit + external benefits
- if there isn’t a consumption externality, then MSB=MPB

Question 7

what is the marginal social cost?

Answer 7

MSC = marginal private cost + external costs

• if there isn’t a production externality, then MSC = MPC

Question 8

individuals only take their own private benefits and costs into account
what don’t they account for?
what does this lead to?

Answer 8

• don’t account for externalities when choosing how much to produce / consume
• therefore the good is over or under provided by the free market
  (externalities cause a partial market failure)

Question 9

what are private costs?

Answer 9

• producers are concerned with private costs of production

eg) rent/costs of machinery and labour/insurance/transport/paying for raw materials

• determines how much the producer will supply
• could refer to the market price which the consumer pays for the good

Question 10

what are social costs?

Answer 10

• calculated by private costs and external costs
• on a diagram
  -> external costs are the difference between private costa and social costs
• marginal social costs (MSC) and marginal private costs (MPC) diverge from each other
  -> external costs increase disproportionately with increased output

Question 11

what are social benefits?

Answer 11

• social benefits are private benefits + external benefits
• on a diagram
  -> external benefits are the difference between private and social benefits
• similarly to external costs, external benefits increase disproportionately as output increases

Question 12

what are private benefits?

Answer 12

• consumers are concerned with the private benefit derived from the consumption of a good
• the price the consumer is prepared to pay determines this
• private benefits could also be a firm’s revenue from a selling a good

Question 13

where is the social optimum position?

Answer 13

where MSC = MSB and it’s the point of maximum welfare

the social costs made from producing the last unit of output is equal to the social benefit derived from consuming the unit of output

Question 14

when do external costs occur?
how are they shown?

Answer 14

• external costs occur when a good is being produced or consumed, such as pollution
• shown by the vertical distance between MSC and MPC

Question 15

what’s ignored at market equilibrium?

Answer 15

• at market equilibrium, where supply = demand at a certain price
• ignores these negative externalities
• leads to over-provision and under-pricing

Question 16

with negative externalities, what happens to MSC and MPC of supply and the free market equilibrium?

Answer 16

• MSC is greater than the MPC of supply
• at the free market equilibrium, there’s an excess of social costs over benefits at the output between Q1 and Qe

Question 17

what is the deadweight welfare loss triangle?
when does it occur?

Answer 17

the output where social costs are greater than private benefits

• the market fails to account for the -ve externalities that occur from the consumption of this good, which would reduce welfare in society if it was left to the free market

Question 18

give an example of an external benefit from the production/consumption of a good
explain this using a diagram

Answer 18

an eg of an external benefit from the production or consumption of a good or service could be the decline of diseases and the healthier lives of consumers through vaccination programmes

• since consumers + producers don’t account for them, they’re under-provided and under-consumed in the free market, where MSB is greater MPB
  -> this leads to market failure
• the triangle in the diagram shows the excess of social benefits over costs, its the area of welfare gains

Question 19

why does the absence of property rights lead to externalities in both production and consumption and hence market failure?

Answer 19

• markets become inefficient when there are no property rights
  eg) it’s practically impossible to establish property rights on goods like sea water and air
  -> this means that free-riders can have unlimited access which results in the exploitation of the good
• the moral hazard assumes someone else will pay the consequences for a poor choice
  eg) some ppl might litter the street if they think that other ppl will clear it up
• scarce resources could be over-used or exploited
  eg) rainforests are depleting and many species of fish are becoming endangered
  -> this is because the environment cannot be protected by applying property rights