Externalities (LS17)

Question 1

A market fails when the..

Answer 1

Price mechanism fails to allocate scarce resources efficiently and society suffers as a result
Common problem and the gov often intervene to try prevent it

Question 2

Private cost

Answer 2

Cost of doing smth to either a consumer/firm

Question 3

External costs

Answer 3

Caused by externalities
If u drop a crisp packet the council has to employ someone to sweep it up

Question 4

Social cost

Answer 4

Private cost + external cost = social cost
Full cost borne by society of a good or service

Question 5

Private benefit

Answer 5

Benefit gained by a consumer or firm by doing smth

Question 6

External benefits

Answer 6

Caused by externalities
Positive externalities are external benefits to a third party

Question 7

Social benefit

Answer 7

Private benefit + external benefit = social benefit
Full benefit recieved by society from a g/s

Question 8

Why does market failure occur

Answer 8

In a free martlet the price mechanism will only take into account rhe private costs and benefits, but not the external costs and benefits

Question 9

Marginal private cost (MPC)

Answer 9

Cost of producing the last unit of a good

Question 10

Marginal social cost (MSC)

Answer 10

Marginal private cost + external cost

Question 11

What is the external cost of production (negative externalities)

Answer 11

The difference between MPC and MSC

Question 12

If the MPC and MSC curves are parallel then..

Answer 12

External costs per unit produced are constant
If the curves diverge the external costs per unit increase with output
Example: external costs per unit created by pollution can increase as output increases

Question 13

Negative externalities from production graph

Answer 13

Question 14

Positive externalities from consumption graph

Answer 14

Question 15

Marginal private benefit (MPB)

Answer 15

Benefit to someone of consuming the last unit of a good

Question 16

Marginal social benefit (MSB)

Answer 16

Marginal private benefit + external benefit

Question 17

What shows the external benefits (positive externalities)

Answer 17

Difference between MPB and MSB

Question 18

If the MPB and MSB curves are parallel then..

Answer 18

External benefits per unit are constant
If they diverge then external benefits per unit increase with production
Example: more people vaccinated, greater benefit for unvaccinated ppl

Question 19

Negative production externalities graph (leads to overproduction)

Answer 19

Question 20

Explain this graph

Answer 20

When supply and demand are equal = equilibrium in free market
In free market consumers and prod only consider private costs - ignore social costs/benefits
Therefore the MPC curve can be seen as the supply curve of a g/s
The MPB curve can be seen as the demand curve

Question 21

What is the socially optimum level on this graph

Answer 21

Where MSC = MSB as this includes external costs and benefits to society
Socially optimum level of output is Q1 and socially optimum price is P1, not Pe and Qe
This output + price will give society max benefit of any positive externalities and still cover costs of any negative externalities
This causes overproduction and underpricing (Qe and Pe)

Question 22

Explain the welfare loss on this diagram

Answer 22

The loss to society by ignoring externalities
For each unit of good produced between q1 and qe the marginal social cost is greater than the marginal social benefit

Question 23

Graph to show positive consumption externalities

Answer 23

Question 24

Explain this graph

Answer 24

In free market only private benefits considered, so output is Qe and price is Pe
Optimal level of output would be Q1 and optimal price is P1
As there are no positive externalities, MPC=MSC (MSC= MPC + MEC)
This causes underconsumption and underpricing
For each unit of thie good consumed between Qe and Q1 the MSB is greater than MSC

Question 25

Explain the welfare gain in this diagram

Answer 25

The area between MSB and MSC is the triangle. Area of potential welfare gain (gain to society lost by ignoring externalities)

Question 26

Examples of services with positive consumption externalities

Answer 26

Education Healthcare

Question 27

Tax on negative externality

Answer 27

Question 28

Subsidy on positive externality

Answer 28

Applicable to merit goods

Question 29

Impact of negative externalities on economic agents

Answer 29

Producers may not fully account external costs, leading to overproduction of goods with negative externalities Consumers may not consider external costs, leading to overconsumption Inefficiency + reduced social welfare overall

Question 30

Impact of positive externalities on economic agents

Answer 30

Producers may not capture all benefits, leading to underproduction or goods with positive externalities Consumers may not fully appreciate external benefits leading to underconsumption Under allocation of resources to beneficial activities overall

Question 31

How do you fix the problem of negative externalities and positive externalities (government intervention

Answer 31

Negative - tax (internalise external costs, reducing overproduction) Positive - subsidy (encourages greater provision of beneficial g/s) Regulations can also be used to limit external costs or promote external benefits

Question 32

Types of market failure

Answer 32

Externalities Under provision of public goods Info gaps

Question 33

How do externalities cause market failure

Answer 33

by decoupling the price of a good from its true social cost or benefit, leading to an inefficient allocation of resources