Externalities

Question 1

When does a market fail?

Answer 1

A market fails when the price mechanism ( forces of supply and demand ) fails to allocate scarce resources efficiently and society suffers as a result.

Question 2

What does market failure bring about?

Answer 2

Market failure brings about government intervention.

Question 3

What occurs in complete market failure?

Answer 3

In complete market failure, no market exists, this is a missing market.

Question 4

What are externalities?

Answer 4

• Externalities are effects that producing or consuming a good/service has on the people who aren’t involved in the making, buying/selling and consumption of the good/
• Alternatively these people are known as third parties.

Question 5

What are the two types of externalities?

Answer 5

• Positive

* Negative

Question 6

What are positive externalities?

Answer 6

External benefits to a third party.

Question 7

What are negative externalities?

Answer 7

External costs to a third party.

Question 8

What two situations may lead to externalities?

Answer 8

• Consumption

* Production

Question 9

What is the private cost?

Answer 9

Cost of doing something to either a consumer or a firm.
Examples:
• A cost a firm pays to make a good is its private cost
• Price a consumer pays to buy the good is their private cost

Question 10

What are external costs caused by?

Answer 10

External costs are caused by externalities

Question 11

What is the social cost?

Answer 11

Full cost borne by society of a good or service

Question 12

How is the social cost worked out?

Answer 12

• Adding the private cost to the external cost

Question 13

What is the private benefit?

Answer 13

Is the benefit gained by a consumer or a firm by doing something.

Question 14

What are the external benefits?

Answer 14

Benefits caused by externalities

Question 15

How is the social benefit worked out?

Answer 15

Private benefit + the external benefit

Question 16

What is the social benefit?

Answer 16

The full benefit received by society from a good or service.

Question 17

Why dose market failure occur?

Answer 17

Market failure occurs because in a free market the price mechanism will only take into account the private costs and benefits but not the external costs and benefits.

Question 18

What is the marginal private cost?

Answer 18

Cost of producing the last unit of a good.

Question 19

What is the marginal social cost?

Answer 19

The private cost + the external cost.

Question 20

How is the external cost of production worked out?

Answer 20

• The difference between the MPC and MSC curves.

* If the curves diverge then external costs per unit increase with output.

Question 21

What happens if the MPC and MSC curves diverge?

Answer 21

The external costs per unit increase with output

Question 22

What happens if the MPC and MSC curves are parallel?

Answer 22

Then external costs per unit produced are constant.

Question 23

What is an example of where the curves may diverge?

Answer 23

The external costs per unit created by the pollution can increase as output increases.

Question 24

What is the marginal private benefit?

Answer 24

The benefit of someone consuming the last unit of a good

Question 25

What is the marginal social benefit?

Answer 25

The marginal private benefit + the external benefit.

Question 26

What is the difference between the MPB and MSB curves?

Answer 26

The positive externalities