1.3.2 Externalities

Question 1

Externalities

Answer 1

economic “spill-over” effects which are not included in the price and impact those not related to the economic transaction (regarded as a market failure)

Question 2

Market failure

Answer 2

a situation in which the free market fails to allocate resources efficiently

Question 3

External costs (negative externalities)

Answer 3

occur when the social costs of an economic action are greater than the private cost (social cost= private cost + external cost) (e.g pollution from factory)

Question 4

External benefits (positive externalities)

Answer 4

occur when the social benefits of an economic action are greater than the private benefits (social benefits = private benefits + external benefits) (education)

Question 5

Explain how education might be an external benefit

Answer 5

• The education received by a child means they can get a job that have reasonable income (private)
• The child’s education may benefit wider society if she becomes a doctor and treat people so they can go to work (external benefit)

Question 6

Private cost and benefit for gum on consumer

Answer 6

• Cost: the price of gum

- Benefits: Enjoyment from eating the gum

Question 7

External cost and benefit for gum on consumer (society)

Answer 7

• Cost: The costs to councils of both scraping off spat-out gum from pavements and collecting discarded packets
• Benefits: oral hygiene

Question 8

Private cost and benefit for gum on producer

Answer 8

• Cost: Manufacturing, marketing costs

- Benefits Sales revenue and profit

Question 9

External cost and benefit for gum on producer

Answer 9

• Cost: Pollution from the factory, congestion from the lorries
• Benefits: None

Question 10

Negative externality diagram

Question 11

Positive externality diagram

Question 12

Impact on economics agents of externalities and govt intervention examples

Answer 12

• gum neg externality: gum on the street which gets stuck on people’s shoes and the govt have to clean (gum have a higher social cost than private cost)

Question 13

Policy options for negative externalities

Answer 13

• “Nudge”
• Prohibition
• Indirect/specific tax
• Quota system
• Regulation
• Information provision
• Subsidise more favourable substitutes

Question 14

Nudge policy for negative externalities

Answer 14

change people’s behaviours e.g by providing easier alternate options (e.g bins for gum)

Question 15

Prohibition for negative externalities

Answer 15

putting a ban on certain things (with penalties)

- gum ban in SIngapore or DDT pesticides being banned

Question 16

Indirect/specific tax for negative externalities

Answer 16

• use tax to offset the externality

- to internalise the externality of the tax passed (so the social cost becomes a private cost (hypothecation)

Question 17

Quota system for negative externalities

Answer 17

the negative externality is capped at a certain amount (e.g carbon trading units) e.g Kyoto Protocol

Question 18

What is the carbon trading scheme?

Answer 18

• a body set a cap on carbon emissions by giving out a certain amount of carbon units
• If a company has more carbon units than needed, than can sell them to other countries/companies
• this makes polluters pay and rewards low carbon emissions

Question 19

Regulation for negative externalities

Answer 19

allow occurrence at certain times

Question 20

Information provision for negative externalities

Answer 20

the impacts of cigarettes on packs

Question 21

Subsidies more favourable for negative externalities

Answer 21

e.g green energy paid for

Question 22

Evaluation of policy for negative externalities

Answer 22

• quantification of the externality & knowing the point at which MSC=MSC is difficult
• putting a monetary value on the deadweight loss is difficult to achieve

Question 23

Disadvantages of Prohibition for negative externalities

Answer 23

may create illegal markets e.g black markets

Question 24

Disadvantages of Indirect/specific tax for negative externalities

Answer 24

the tax effects may be regressive and the impacts may fall more heavily for poorer people

Question 25

DIsadvantages of regulation

Answer 25

• the costs of implementation

- monitoring & managing some of the options may be prohibitive

Question 26

Disadvantages of Quota system for negative externalities

Answer 26

global agreements are very difficult to achieve

Question 27

Disadvantages of Subsidies more favourable for negative externalities

Answer 27

subsidies have financial & opportunity costs which may create a dependency on the subsidy

Question 28

Positive externalities in consumption definition

Answer 28

a situation in which the free market leads to an under-consumption of a g/s relative to the social optimal (e.g education and vaccines)

Question 29

Diagram to show a positive consumption externality:

Question 30

Diagram to show a positive consumption externality with subsidy:

Question 31

How to achieve the social optimal/ social efficiency/welfare maximising (increase consumption of positive externalities)?

Answer 31

• Subsidise to push the price down to achieve the socially optimal quantity
• Compulsion / mandatory (eg education / Tetanus MMR vaccines)
• State provision free of charge

Question 32

Positive consumption externality diagram explanation

Answer 32

• where MPC (s) = MPB (d)
• the social efficient equilibrium is higher the market equilibrium since the MSB (social benefit) is greater than the MPB (private benefit)
• the welfare gain is the external benefit that the market has used due to underconsumption

Question 33

Result of positive externalities

Answer 33

• creates a 3rd party spillover benefit
• the social benefit of production/consumption is greater than the private benefit
• external benefit might be in the form of lower cost for other parties or increased revenue/profits for other parties

Question 34

Why is education a merit good?

Answer 34

• Private benefit: job and income
• Social benefit: better skills= increased productivity, more social opportunities, increased living standards, higher income= more consumption and money spent on economy/expenditure, increase in tax revenue to govt = government expenditure

Question 35

Advantages of imposing an extra charge for vehicles

Answer 35

• allows polluters to pay for negative externalities
• taxes as a hard nudge to drive investment )buy less polluting cars)

Question 36

Disadvantages of imposing an extra charge for vehicles

Answer 36

• regressive effect on poorer households (= increase demand of public transport)
• small businesses face extra costs = reduce profits = contraction in employment
• other alternatives = have car free days