CH17 Externalities

Question 1

when are externalities created?

Answer 1

When social costs and benefits differ from private costs and benefits.

Question 2

the greater the externality, the what?

Answer 2

The greater the likelihood of market failure

Question 3

when does market failure occur?

Answer 3

Market failure occurs when marginal social cost and marginal social benefit are not equal at the actual level of output. There will be a welfare loss or welfare gain at this level of output shown by the ‘welfare’ triangle on a marginal social and private cost and benefit diagram.

Question 4

give an example of an externality or spill over effects? (hint: chemical plant)

Answer 4

A chemical plant may dump waste into a river in order to minimise its costs. Further down the river, a water company has to treat the water to remove dangerous chemicals before supplying drinking water to its customers. Its customers have to pay higher prices because of the pollution.

Question 5

when do externalities arise?

Answer 5

when private costs and benefits are different from social costs and benefits.

Question 6

what is a private cost?

Answer 6

A private cost is the cost of an activity to an individual economic unit, such as a consumer or a firm

Question 7

what is a social cost?

Answer 7

A social cost is the cost of an activity not just to the individual economic unit which creates the cost, but to the rest of society as well. It therefore includes all private costs, but may also include other costs

Question 8

the difference between private cost and social cost is what?

Answer 8

It is the externality or spill over effect.

Question 9

if social cost is greater than private cost, then what is said to exist?

Answer 9

Then a negative externality or external cost is said to exist.

Question 10

are all externalities negative?

Answer 10

No. A company may put up a building which is not just functional but also beautiful. The value of the pleasure which the building gives to society over its lifetime (the social benefit) may well far exceed the benefit of the building received by the company (the private benefit). Hence, if social benefit is greater than private benefit, a positive externality or external benefit is said to exist’

Question 11

When is a positive externality or external benefit said to exist?

Answer 11

When social benefit is greater than private benefit.

Question 12

can positive externalities result from education and training?

Answer 12

Yes. An individual may benefit in the form of a better job and a higher salary but society may gain even more from the benefit of a better trained workforce.

Question 13

What is meant by production externalities?

Answer 13

these arise when the social costs of production differ from the private costs of production

Question 14

when do negative externalities of production occur?

Answer 14

these occur when social costs are greater than private costs in production.
-an example is when a factory pumps sewage into a river at no cost to itself.

Question 15

when do positive externalities of production occur?

Answer 15

these occur when social costs are less than private costs in production.
-an example would be a supermarket which redeveloped a derelict industrial site for a new store but at the same time cleaned up pollution on the site, improved the roads around the site and subsidised the construction of some social housing next to the new store.

Question 16

when do positive externalities of consumption occur?

Answer 16

when social benefits are greater than private benefits in consumption.
-for example, when a child is immunised against chickenpox, it makes it less likely that another unimmunised child in the local area will get chickenpox

Question 17

when do negative externalities of consumption occur?

Answer 17

these occur when social benefits are less than private benefits in consumption.
-for example, with passive smoking, a person who smokes in their homes harms the health of others in the home.

Question 18

when will a misallocation of resources occur?

Answer 18

a misallocation of resources will occur if market prices do not accurately reflect the costs and benefits to society of economic activities.

Question 19

the greater the externality, the larger the what?

Answer 19

-the greater the externality, the larger will be the divergence between private costs and benefits and social costs and benefits.
-the greater the externality, the greater the market failure and the less market prices provide accurate signals for the optimal allocation of resources.

Question 20

as the level of output changes, the difference between what also changes? how can this be shown?

Answer 20

the difference between social costs and social benefits changes as the level of output changes.
-this can be shown using marginal analysis. The margin is a possible point of change. So the marginal cost of production is the extra cost of producing an extra unit of output. The marginal benefit is the benefit received from consuming an extra unit of output

Question 21

why is the marginal cost curve in the optimal production and consumption graph shown as falling at first and then rising?

Answer 21

This is because marginal costs fall at first because producing more can lead to greater efficiencies. However, they then start to rise. This can be because a firm is having to pay higher prices to obtain more factors of production. For example, to employ more workers it might have to offer higher wages. Or production might be less efficient if a firm is operating beyond its optimum capacity of production.

Question 22

In contrast to the marginal cost curve, why does the marginal benefit of consumption curve in the optimal production and consumption graph fall as consumption increases?

Answer 22

This is because each extra unit of consumption brings less benefit to the consumer. It’s the law of … (find the name of the law and add it)

Question 23

What does it mean when the quantity produced and consumed is greater than the equilibrium level in an optimal production and consumption graph? And how would welfare be improved?

Answer 23

it means that the extra cost of production would be greater than the extra benefit from consumption. Welfare would be improved by reducing production and consumption. So this would lead to an inefficient allocation of resources.

Question 24

What does it mean if the quantity produced and consumed is less than the equilibrium point in an optimal production and consumption graph? And how could welfare be increased?

Answer 24

It means the marginal benefit of production is greater than the marginal cost of production. Welfare could be increased if production and consumption were increased.