T1.3: Externalities, Market Failure, Marginals And Social Welfare

Question 1

Externalities

Answer 1

Externalities are third party effects arising from production and consumption of goods and services for which no appropriate compensation is paid.

Question 2

Information gap

Answer 2

when either the buyer or seller does not have access to the information needed for them to make a fully informed decision.

Question 3

Market failure

Answer 3

when the competitive outcome of markets is not efficient from the point of view of the economy as a whole. This is usually because the benefits that the market confers on individuals or firms carrying out a particular activity diverge from the benefits to society as a whole.

Question 4

Public goods

Answer 4

Pure public goods are non-rival – consumption of the good by one person does not reduce the amount available for consumption by another person
- classed as non-excludable

Question 5

Deadweight loss

Answer 5

• loss in producer and consumer surplus due to inefficient production levels —> perhaps market failure or government failure

Question 6

External benefit

Answer 6

A benefit to a 3rd party agent arising from production and/or consumption.

Question 7

External costs

Answer 7

External costs are those costs faced by a third party for which no appropriate compensation is forthcoming. Identifying and then estimating a monetary value for air and noise pollution is a difficult exercise - but one that is important for economists concerned with the impact of economic activity on our environment.

Question 8

Externalities

Answer 8

third party effects arising from production and consumption of goods and services for which no appropriate compensation is paid.

Question 9

Marginal external benefit (MEB)

Answer 9

Benefit to third parties from the consumption of extra unit of output.

Question 10

Marginal external cost (MEC)

Answer 10

Cost to third parties from the production of an additional unit of output.

Question 11

Marginal private benefit (MPB)

Answer 11

Benefit to the consumer of consuming an extra unit of output.

Question 12

Marginal private cost (MPC)

Answer 12

Cost to the producing firm of producing an additional unit of output.

Question 13

Marginal social benefit (MSB)

Answer 13

Total benefit to society from consuming an extra unit, MSB = MPB + MEB.

Question 14

Marginal social cost (MSC)

Answer 14

Total cost to society of producing an extra unit of output. MSC = MPC + MEC.

Question 15

Negative externality

Answer 15

Negative externalities occur when production and/or consumption impose external costs on third parties outside of the market for which no appropriate compensation is paid. This causes social costs to exceed private costs.

Question 16

Net social benefit

Answer 16

A measurement of the net impact of an investment project found by estimating the social costs and benefits —> considered by a government when deciding which project(s) offers best potential return

Question 17

Positive externalities

Answer 17

exist when third parties benefit from the spill-over effects of production/consumption e.g. the social returns from investment in education & training or the positive benefits from health care and medical research.

Question 18

Private benefit

Answer 18

The rewards to individuals, firms or consumers from consuming or producing goods and services. Also known as internal benefit.

Question 19

Private cost

Answer 19

Costs of an economic activity to individuals and firms. Also known as internal costs.

Question 20

Social benefit

Answer 20

The benefit of production or consumption of a product for society as a whole. Social benefit = private benefit + external benefit.

Question 21

Social cost

Answer 21

The cost of production or consumption of a product for society as a whole. Social cost = private cost + external cost.

Question 22

Social efficiency

Answer 22

The socially efficient output is where Social Marginal Cost (SMC) = Social Marginal Benefit (SMB).

Question 23

Spill-over effects

Answer 23

External effects of economic activity, which have an impact on outsiders who are not producing or consuming a product – these can be negative (creating external costs) or positive (creating external benefits).

Question 24

Excludability

Answer 24

Property of a good whereby a person can be prevented from using it if they do not pay.

Question 25

Free rider problem

Answer 25

public goods are non-excludable it is difficult to charge people for benefitting once a product is available. The free rider problem leads to under- provision of a good and thus causes market failure. Free riders have no incentive to reveal how much they are willing and able to pay for a public good because they can enjoy benefit without paying.