Externalities

Question 1

When are externalities created?

Answer 1

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

Question 2

What are the two types of externalities?

Answer 2

1) Negative externalities/external costs.
2) Positive externalities/external benefits.

Question 3

What are the two types of negative externalities/external costs?

Answer 3

1) Private costs - the costs to an individual economic agent.
2) Social costs - the costs to individuals and society.

Question 4

What are the two types of positive externalities/external benefits?

Answer 4

1) Private benefits - the benefits to an individual economic agent.
2) Social benefits - the benefits to individuals and society.

Question 5

What is the formula for social costs?

Answer 5

Social cost = private cost + external cost

Question 6

What is the formula for social benefits?

Answer 6

Social benefit = private benefit + external benefit

Question 7

What is marginal social cost (MSC)?

Answer 7

The total cost to society from the production or consumption of an extra unit of a good or service.

Question 8

What is marginal social benefit (MSB)?

Answer 8

The total benefit gained by society from the production or consumption of an extra unit of a good or service.

Question 9

What is marginal private cost (MPC)?

Answer 9

The total cost to an individual economic agent from the production or consumption of an extra unit of a good or service.

Question 10

What is marginal private benefit (MPB)?

Answer 10

The total benefit gained by an individual economic agent gained from the production or consumption of an extra unit of a good or service.

Question 11

What are production externalities?

Answer 11

Externalities that arise from the production of goods and services.

Question 12

What are consumption externalities?

Answer 12

Externalities that arise from the consumption of goods and services.

Question 13

What are 3 examples of negative production externalities?

Answer 13

1) Damage to the environment from factories, farming, construction, etc.
2) Noise pollution from the airline industry.
3) Over-fishing of the seas.

Question 14

What are 2 examples of positive production externalities?

Answer 14

1) Redevelopment of an industrial site for retail.
2) Subsidised construction of social housing.

Question 15

What are 3 examples of negative consumption externalities?

Answer 15

1) Passive smoking.
2) Environmental damage from consumption, e.g. household waste.
3) Anti-social behaviour from a sporting event.

Question 16

What are 3 examples of positive consumption externalities?

Answer 16

1) Vaccinations.
2) High quality education for children.
3) Health benefits from the consumption of a merit good.

Question 17

Why is the MPB curve upwards sloping?

Answer 17

Because marginal costs increase as output rises.

Question 18

Why is the MPC curve downwards sloping?

Answer 18

Because utility falls for each additional unit consumed.

Question 19

Does MPB = MSB = Demand?

Answer 19

Yes.

Question 20

What is welfare loss?

Answer 20

When a negative externality is created for the wider community through the consumption/production of a good/service.

Question 21

What is a welfare gain?

Answer 21

When a positive externality is created for the wider community through the consumption/production of a good/service. E.g. by providing a merit good/service, like gym memberships.

Question 22

Where is welfare loss on an externality diagram?

Answer 22

The triangle between MSC, MPC and D = MSB + MPB.

Question 23

Where is welfare gain on an externality diagram?

Answer 23

The triangle between MSB, MSC = MPC and D = MPB.

Question 24

Where is the equilibrium point on an externality diagram?

Answer 24

Where MPC = MPB.

Question 25

Where is the socially optimum level of output on an externality diagram?

Answer 25

Where MSC = MSB.

Question 26

When there are negative externalities, where will the socially optimum level of output be?

Answer 26

Below the free market equilibrium.

Question 27

When there are positive externalities, where will the socially optimum level of output be?

Answer 27

Above the free market equilibrium.

Question 28

What are 4 examples of positive externalities/external benefits?

Answer 28

1) Sustainable production - recycling, ‘green’ businesses, etc.
2) Attractive and desirable places to live - architecture and art.
3) Improved national health.
4) A happy society with confident consumers.

Question 29

What are 4 examples of negative externalities/external costs?

Answer 29

1) Damage to the environment through global warming and resource depletion.
2) Closure of small businesses and the loss of jobs.
3) Damage to national health through the consumption of de-merit goods.
4) Social problems, such as antisocial behaviour or loss of culture and community.

Question 30

What are the three types of government intervention to correct negative externalities?

Answer 30

1) Subsidies.
2) Indirect taxation.
3) Regulation of markets.

Question 31

How can subsidies correct market failure from negative externalities?

Answer 31

Subsidies reduce costs of production, incentivising the production of merit goods that may benefit society or protect an industry.

Question 32

How can indirect taxation correct market failure from negative externalities?

Answer 32

Indirect taxation raises production costs as well as prices for certain goods which may have negative externalities, discouraging production and consumption.

Question 33

How can the regulation of markets correct market failure from negative externalities?

Answer 33

Governments can intervene to prevent/minimise the misallocation of resources.