Negative Externalities

Question 1

Private costs

Answer 1

A cost to a producer inside the price mechanism.

Question 2

Negative externalities (or external costs)

Answer 2

Costs which affect third parties outside the price mechanism.

Question 3

Socially efficient equilibrium

Answer 3

Where MSC = MSB and society’s welfare is maximised.

Question 4

Tradable pollution permits

Answer 4

Permits which allow firms to pollute up to a certain limit. These permits can then be traded between firms.

E.g. Europe’s Emissions Trading Scheme (ETS). The EU government set a cap of 2bn tonnes of CO2, and issued permits to firms. It held the last 10% of permits back for auction.

Question 5

Minimum price

Answer 5

The lowest price a good can be legally sold for.

E.g. Scotland’s minimum price on alcohol is 50p per unit of alcohol.

Note: a minimum price must be set above the market price otherwise it will have no effect.

Question 6

Regulation

Answer 6

When the government makes changes to the law to address market failure.

E.g. the Firearms Act which made it illegal to buy a handgun in the UK.

Question 7

Negative consumption externalities (or external costs of consumption)

Answer 7

When the consumption of a good creates costs to third parties outside the price mechanism.

E.g. consuming cigarettes will damage the health of others via passive smoking.

Question 8

Negative production externalities (or external costs of production)

Answer 8

When the production of a good creates costs to third parties outside the price mechanism.

E.g. a factory producing nuclear bombs will pollute nearby rivers with radiation.