Negative externalities

Question 1

What is a negative production externality?

Answer 1

A third party or spillover external cost arising from the production of a good for which no compensation is paid eg: pollution

Question 2

What is a negative consumption externality?

Answer 2

A third party or spillover external cost arising from the consumption of a good for which no compensation is paid eg: tobacco consumption causing passive smoking

Question 3

What is the formula for social benefit?

Answer 3

Private benefit + external benefit

Question 4

What is social cost?

Answer 4

Private cost + external cost

Question 5

What is marginal private cost?

Answer 5

All the costs of producing one more unit of the good to the producer

Question 6

What is marginal social cost?

Answer 6

All the costs of producing one more unit of the good to society

Question 7

What is marginal private benefit?

Answer 7

All the benefits of consuming one more unit of the good to the consumer

Question 8

What is marginal social benefit?

Answer 8

All the benefits of consuming one more unit to society

Question 9

When does allocative efficiency exist in a perfect market?

Answer 9

When P = MC

Question 10

When does allocative efficiency exist if there are externalities?

Answer 10

When MSC = MSB

Question 11

What happens to the market when there is negative consumption externality?

Answer 11

The market will over provide since there are too many scarce resources allocated to the production and consumption of the good meaning there is a net welfare loss in the market

Question 12

What are examples for negative production externalities?

Answer 12

Air, noise, water pollution and environmental damage

Question 13

What are examples for negative consumption externalities?

Answer 13

tobacco, alcohol, gambling, obesity, congestion

Question 14

How do government policies help negative externalities?

Answer 14

Policies help reduce negative externalities, which internalise the externalities eg: polluter pays principle

Question 15

What are examples of government policies against negative externalities?

Answer 15

Banning / restricting output - ban results in no output so it is used when the negative externality is very large

Legislation/regulations - rules to restrict pollution

“Nudge policies” - uses behavioural methods to encourage to encourage less pollution

Indirect tax - shifts MPC towards MSC curve

Pollution permit trading schemes - creates incentives for firms to pollute less and for high polluting firms to cut output