Externalities

Question 1

What are externalities?

Answer 1

Externalities are spill-over effects which occur from production and consumption for which no appropriate compensation is paid/received.

Question 2

Why do externalities cause market failure?

Answer 2

Externalities cause market failure if the price mechanism does not take into account the social costs/benefits of production and consumption.

Question 3

What are the three types of costs/benefits that can occur?

Answer 3

1) Social costs/benefits
2) Private costs/benefits
3) External costs/benefits

Question 4

What are social costs/benefits?

Answer 4

Social costs and benefits are the costs/benefits of the activity to society as a whole. (Private costs/benefits + external costs)

Question 5

What are private costs/benefits?

Answer 5

Private costs/benefits are the costs/benefits faced by either the producer or consumer directly involved in an economic transactions. (Private benefits can also be faced by the producer and consumer at the same time)

Question 6

What are external costs/benefits?

Answer 6

They are the costs/benefits to a third party not involved in the economic
activity.

Question 7

What is marginal social cost (MSC) ?

Answer 7

The cost to society of producing an extra unit of a good

Question 8

What is marginal social benefit (MSB) ?

Answer 8

The benefit received by society from consuming an extra unit of a good

Question 9

What is marginal private cost (MPC) ?

Answer 9

Is the extra cost to the individual from producing one more of the good

Question 10

What is marginal private benefit (MPB) ?

Answer 10

Is the extra satisfaction gained by the individual from consuming one more of a good

Question 11

What is marginal private benefit (MPB) ?

Question 12

What are negative production/consumption externalities?

Answer 12

Negative externalities of production occur when social costs are greater than private costs. 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.

Question 13

What are government interventions?

Answer 13

Governments intervene in markets to try and overcome market failure

Question 14

GI : Indirect taxes and subsidies

Answer 14

Taxes can be put on goods with negative externalities
and subsidies on goods with positive externalities. These help to internalise the
externalities, moving production closer to the social optimum position.

Question 15

GI : Tradable pollution permits

Answer 15

These allow firms to produce up to a certain amount of
pollution, and can be traded amongst firms so give them choice whilst reducing the
total level of pollution

Question 16

GI : Provision of the good

Answer 16

When social benefits are very high, the government may
decide to provide the good through taxation. They do this with healthcare and
education

Question 17

GI : Provision of information

Answer 17

Since some externalities are associated with information
gaps, the government can provide information to help people make informed
decisions and acknowledge external costs

Question 18

GI : Regulation

Answer 18

This could limit consumption of goods with negative externalities, for
example banning advertising of smoking etc