Externalities (1.3.2)

Question 1

Define externalities

Answer 1

Impact on third parties that weren’t involved in the transaction but have been affected by that good or service being consumed. Can be positive or negative impact. This impact can be on the consumption side of the market or the production side of the market.

Question 2

What are Positive Externalities?

Answer 2

An external benefit on a third party. Goods/ Services that benefit 3rd parties are under-consumed because we either aren’t aware of the benefits or ignore them.

Question 3

What’s an example of a Positive Externality?

Answer 3

e.g. When a person eats healthy then they have a less likely chance of having health problems so don’t cost the NHS more. So by eating healthy they are saving the nurses by not making them treat them so the nurses are positively affected as they don’t have to treat the person.

Question 4

What are Negative Externalities?

Answer 4

An external cost on a third party. Goods/ Services that damage 3rd parties are over-consumed because we either aren’t aware of the dangers or ignore them.

Question 5

What’s an example of a Negative Externality?

Answer 5

e.g. when a smoker smokes the smoke goes into another persons face and affects their health. so the person affected by the smokers smoke is the third party as they haven’t done anything wrong but are getting affected.

Question 6

Out of positive and negative externalities which one is under-consumed and which one is over-consumed?

Answer 6

Positive Externalities = Under-consumed
Negative Externalities= Over-consumed

Question 7

What are External costs/benefits?

Answer 7

The costs/benefits to a third party not involved in the economic activity. Difference between Private costs/benefits and social costs/benefits.

Question 8

What are private costs/benefits?

Answer 8

Costs/Benefits to the individual participating in the economic activity. Demand curve represents Private benefits and the supply curve represents private costs.

Question 9

What are Social Costs/benefits?

Answer 9

The costs/benefits of the activity to society as a whole

Question 10

What graph do we use instead of the Supply and Demand Graph?

Answer 10

MPC/MPB
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Question 11

What do MPC and MPB mean?

Answer 11

MPC-Marginal Private Cost: Cost of producing the Good or Service

MPB-Marginal Private Benefit: This is the benefit of consuming the Good or Service

Question 12

If the cause of the Externality is Production will it shift MPC or MPB?

Answer 12

MPC

Question 13

If the cause of the Externality is Consumption will it shift MPC or MPB?

Answer 13

MPB

Question 14

What are the positives and negatives of Production (MPC)?

Answer 14

Positives:
-Military Innovation + Products

Negatives:
-Manufacturing + Pollution
-Distribution +Traffic

Question 15

What are the positives and negatives of Consumption (MPB)?

Answer 15

Positives:
-Education and Employment

Negatives:
-Smoking + Second-Hand Smoking
-Fatty Foods + NHS burden

Question 16

If there is a Negative Externality of Production what line shifts and in which direction on a graph?

Answer 16

MPC shifts to the left. MPC then changes to MSC (Marginal Social Cost)

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Question 17

What is Marginal Social Cost (MSC)?

Answer 17

Marginal Private Cost +External cost

Total cost to society of producing one more unit of a good or service.

Question 18

What does P2Q2 show on the graph?

Answer 18

P2Q2 is socially optimum equilibrium if we consider impact on third party consumers.

P1-P2 shows the good is underpriced and Q1-Q2 shows the good is over-produced

Question 19

What is deadweight loss? Where is it on a graph?

Answer 19

Shading an area under or over consumption of a good or service. This is where the market is not operating efficiently.

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Question 20

What ways do MPB and MPC shift with positive and negative externalities?

Answer 20

MPB:
-Positive= Shifts right to be MSB
-Negative=Shifts left to be MSB

MPC:
-Positive= Shifts right to be MSC
-Negative= Shifts left to be MSC

Slide 46

Question 21

What are the ways in which the government can intervene to ensure the market considers the external costs and benefits?

Answer 21

1.Indirect taxes and subsidies-Taxes can be put on goods with negative externalities and subsidies on goods with positive externalities. This helps move production to the social optimum position.
2.Tradeable Pollution Permits- Allow firms to produce up to certain amount of pollution and can be traded amongst firms. Helps reduce level of pollution.
3. Provision of the good- When social benefits are high, gov may decide to provide the good through taxation. Do this with healthcare and education.
4. Provision of Information- Gov can provide info to help make informed decisions and acknowledge external costs as some externalities associated with information gaps.
5.Regulation- Could limit consumption of goods with negative externalities. E.g. banning advertising smoking