1.1.13: Externalities

Question 1

Define the term “external costs” (1 mark)

Answer 1

Negative spillover effects of consumption/production that affect third parties.

Question 2

State and explain 2 examples of external costs. (4 marks)

Answer 2

Pollution and environmental damage - indirectly affects citizens, causing worse air quality, noise and water quality.

Congestion (traffic and overcrowding) - indirectly causes overcrowding o citizens and traic ams that can cause car crashes.

Question 3

Define “external benefits” (1 mark)

Answer 3

Positive spillover efects of consumption or production that brings benefits to third parties.

Question 4

Explain why education is a external benefit. (3 marks)

Answer 4

Those who attend schools and universities will clearly benefit from education. They are more likely to get better jobs, earn more money and enjoy a better quality of life. However, this is only private beneit. This beneit can ONLY be enjoyed by those who “consume” education.

Education could also benefit the wider society. If people are more educated, they may do highly skilled and socially useful jobs. As a result, productivity will be higher and the quality of lie as a whole society will rise. Higher levels of education will lower unemployment, improve household mobility and raise rates of political participation which will benefit wider society.

Question 5

Explain why healthcare is a external benefit. (3 marks)

Answer 5

Individuals that consume healthcare will benefit if their own personal health improves. They will feel less pain, can return to work and enjoy life more. This is once again private benefit.

They will also benefit third parties. If people are healthier, they are able to work more effectively making contributions to economic output and paying taxes.

Question 6

Explain why Vaccinations are one of the examples of external benefits. (3 marks)

Answer 6

If an individual receives an inection to protect against an infectious disease, he or she benefits directly. This is obviously beneficial to the individual but third parties will also benefit, which is the external benefit. This is because if more individuals are given vaccinations to prevent infection, the likeliness of others (who do not get vaccinated) contracting disease is lower.

Question 7

Define “private costs” (1 mark)

Answer 7

Costs of an economic activity to individuals and firms.

Question 8

Define the term “Social Cost” (1 mark)

Answer 8

Costs of an economic activity to society as well as the individual or firm.

Question 9

State the formula for social costs. (1 mark)

Answer 9

Social Cost = Private Costs + External Costs (Negative Externalities)

Question 10

Define the term “Private Benefits” (1 mark)

Answer 10

Benefits of an economic activity to invididuals and firms.

Question 11

Define the term “Social Benefits” (1 mark)

Answer 11

Benefits of an economic activity to society as well as to the individual or firm.

Question 12

State the formula for social benefits (1 mark)

Answer 12

Social Benefits = Private Beneits + External Benefits (positive externalities)

Question 13

State the 5 methods of government policies to deal with externalities. (5 marks)

Government intervention has been moved from 1.1.13 to 1.2.6 a

Answer 13

Taxation, Subsidies, Fines, Government Regulation and Pollution Permits.

Question 14

Explain how the government can use Taxation to reduce external costs of production and consumption and one disadvantage or using taxation to reduce external costs of consumption. (6 marks)

Answer 14

Taxation can be used to reduce the external costs of production. For example, if a tax is imposed on a chemical firm that produces damaging emissions, production costs will increase and the prices charged by a firm will rise. This should result in a fall in demand or the firm’s product and thereore a reduction in pollution.

Taxes can also be used to reduce the external cost of consumption. For example, high taxes on cigarettes should reduce supply, which will raise the price. As a result the demand for cigarettes should all and fewer third partkies will be affected by the smoke. However, cigarettes are addictive and when prices rise as a result of the tax, demand may not fall very much.

Question 15

Explain how the government can use subsidies to reduce external costs of production and increase external benefits. (6 marks)

Answer 15

The government can oer money, such as subsidies to irms as an incentive to reduce external costs. or example, a firm might receive a subsidy if it builds a plastics recycling plant. This might encourage households and firms to recycle their plastic waste instead of dumping it.

The government can also give subsidies to irms that generate external benefits. For example, some governments around the world have given subsidies to producers of solar energy. This results in an increase in the supply of solar energy, which should stimulate more demand. If more solar energy is used to generate power, then less “emissions” will be produced, which should beneit the environment.

Question 16

State one weakness of subsidies. (2 marks)

Answer 16

Subsidies to university students in the form of grants, should encourage more people into higher education. As a result, the wider society should benefit from a more educated population.

However, government subsidies contain opportunity cost. The money spent on subsidies to reduce external costs or raise external benefits might be spent more effectively on other government projects.

Question 17

Explain hwo the implementation of fines can reduce external costs (