Externalities: Market Failure - Micro

Question 1

Define externalities

Answer 1

The impact producing/consuming a good/service has on a third party

Question 2

Which curve shifts when there are consumption externalities?

Answer 2

The benefit curve
- MPB (= demand curve). This then shifts and becomes the MSB/MSC
*this is because externalities are the impact on a third party so we measure the social cost/benefit instead on the private one

Question 3

Which curve shifts when there are production externalities?

Answer 3

The supply curve
- MPC (=supply curve). This then shifts and becomes the MSC/MSB
*this is because externalities are the impact on a third party so we can’t measure the cost to the firm

Question 4

What is the label on the Y axis of an externalities diagram?

Answer 4

Price/revenue/cost

Question 5

What is the label on the X axis of an externalities diagram?

Answer 5

Output

Question 6

Define the welfare loss

Answer 6

The loss/gain an economy experiences because they are not operating at their social optimum

Question 7

Define information failure

Answer 7

When the buyer and/or seller has incomplete information

Question 8

Define homo economicus

Answer 8

One who avoids unnecessary work, makes optimal decisions with perfect information by using rational judgement

Question 9

Define merit goods

Answer 9

• goods that have positive externalities (on the individual) that are caused by information failure at the point of consumption
• undervalued and underconsumed in a free market (because consumers don’t often recognise the full benefits at the point of consumption)

Question 10

Define demerit goods

Answer 10

• goods that have negative externalities (on the individual) that are caused by information failure at the point of consumption
• true utility is overvalued - causes overconsumption in a free market- consumers overpay for the good