A2.03.04: Negative Externalities

Question 1

Define negative externalities in production

Answer 1

Costs directly affecting economic agents as a result of the actions of producers

Question 2

Give 3 examples of negative externalities in production and the 3rd party affected

Answer 2

• Air pollution: 3rd party is local residents that suffer from respiratory problems as a result of chemicals or metals being produced and air pollution being produced as a byproduct
• Resource Depletion: 3rd party are future generations that suffer from a loss of income and not being able to consume the goods and services made out of those resources
• Resource Degradation: 3rd party are local residents suffer from contaminated water after firms dump waste being produced as a byproduct into nearby rivers as local residents may utilise the water.

Question 3

How does the negative externalities in production graph look

Answer 3

MPC < MSC

Question 4

Highlight the theory behind negative externalities in production

Answer 4

• Individual firms ignore the full social costs and only consider their private costs because of self-interest
• Thus, the market allocates resources at the private optimum point which means there is an over-production of these goods and services
• Additionally, the price is too low which encourages more consumption of these goods thus, also resulting in the over-consumption of these goods and services
• Therefore, resulting in misallocation of resources, allocative inefficiency and a deadweight loss

Question 5

Define negative externalities in consumption

Answer 5

Costs to 3rd parties as a result of the actions of consumers

Question 6

Give 3 examples of negative externalities in consumption and the 3rd parties affected

Answer 6

• Smoking: 3rd party are individuals who aren’t smoking and are near these individuals suffer from the same respiratory problems
• Excessive alcohol: 3rd party are health services or police services that suffer as they have to treat them or deal with the crimes caused as a result thus, govs suffer from the extrac costs of these services
• Excessive unhealthy food: 3rd party are health services that may suffer from the extra costs of treatment as a result of obesity related issues or employers may suffer from lost productivity as a result

Question 7

How would the graph of negative externalities in consumption look like

Answer 7

• MSB < MPB

Question 8

Highlight the theory behind negative externalities in consumption

Answer 8

• Individual consumers are ignoring their full social benefits and are only considering their private benefits because of self-interest
• Thus, the market allocates resources at the private optimum instead of the social optimum which means there is an over-production and over-consumption of these resources
• Therefore, resulting in a misallocation of resources, allocative inefficiency and a deadweight loss

Question 9

with negative externalities is there an over or under-consumption/production of goods and services

Answer 9

• Overconsumption and overproduction of goods and services

Question 10

what is true about all externalities in production (what does it affect, costs or benefits)

Answer 10

• Costs

Question 11

Which side is the area showing the deadweight loss pointing to the social optimum in negative externalities

Answer 11

• Right side

Question 12

What does the vertical shift in negative externalities represent

Answer 12

The vertical shift represents the value of the external costs that are gained as these firms are acting on self-interest in producing from these resources