Topic 5: Market Failures- Externalities

Question 1

define externalities

Answer 1

occur when economic activities affect third parties who are not involved in this activity
o A source of market failure

Question 2

explain private and social costs

Answer 2

• Private cost (marginal cost/supply curve of individual firm): The cost borne by the producer of a good or service
• Social cost: The total cost of producing a good, including both the private cost and any external cost.

Question 3

explain private and social benefit

Answer 3

• Private benefit (marginal benefit/demand curve of individual good): The benefit received by the consumer of a good or service.
• Social benefit: The total benefit from consuming a good, including both the private benefit and any external benefit

Question 4

what causes externalities

Answer 4

• Absence of private property rights

Question 5

where on a externality graph is the DWL

Answer 5

At Q0 up

Question 6

what occurs when negative externality in production

Answer 6

• supply curve up

- decrease production (Qoptimum

Question 7

what occurs when positive externality in production

Answer 7

• supply curve down

- increase production (Qmarket> Qoptimum)

Question 8

what occurs when negative externality in consumption

Answer 8

• demand shift left

- decrease consumption (Qoptimum

Question 9

what occurs when positive externality in consumption

Answer 9

• demand shift right
• increase production
  (Qmarket > Qoptimum

Question 10

for negative externalities, what is the the difference between market output and socially desirable, and how can this be fixed

Answer 10

• produce/consume larger than socially desirable

- taxes to lower consumption/ production

Question 11

for positive externalities, what is the the difference between market output and socially desirable, and how can this be fixed

Answer 11

• produce/consume smaller than socially desirable

- subsidies to increase consumption/ production