1.3.2 Externalities

Question 1

What are externalities?

Answer 1

The effects that producing or consuming a good/service has on people who aren’t involved in the making, buying/selling and consumption of the good/service.

Question 2

What are positive externalities?

Answer 2

The external benefits to a third party

Question 3

What are negative externalities?

Answer 3

The external costs to a third party

Question 4

When do externalities arise?

Answer 4

When Private costs and benefits are different from social costs and benefits.

Question 5

What is a private cost?

Answer 5

The cost of an activity to an individual economic unit, such as a consumer or a firm.

Question 6

Give an example of a private cost

Answer 6

• A chemical company will have to pay for workers, raw materials and plant and machinery when it produces chemicals.

Question 7

What is a social cost?

Answer 7

The cost of an activity not just to the individual economic unit which creates the cost, but to the rest of society as well.

Question 8

Give an example of a social cost

Answer 8

• The chemical manufacturer may make little or no payment for the pollution it generates

Question 9

What is the difference between private costs and social costs?

Answer 9

The externality/ spill over effect

Question 10

When Social Costs > Private Costs …

Answer 10

There is a negative externality

Question 11

When Social Benefit > Private Benefit…

Answer 11

There is a positive externality

Question 12

When do Negative externalities of production occur?

Answer 12

When social costs > Private costs in production

Question 13

Give an example of a Negative externality of production

Answer 13

When a factory pumps sewage into a river at no cost to itself

Question 14

When do positive externalities of production occur?

Answer 14

When social costs < Private costs in production

Question 15

Give an example of positive externalities of production

Answer 15

A supermarket which redeveloped a derelict industrial site for a new stirred but at the same time cleaned up pollution on the site, improved the roads a round the the site and subsidised the construction of some social housing next to the new store.

Question 16

When do production externalities arise?

Answer 16

When social costs of production differ from the private costs of production

Question 17

When do consumption externalities arise?

Answer 17

When the social benefits of consumption differ from the private benefits of consumption

Question 18

When does positive externalities of consumption occur?

Answer 18

When social benefits > private benefits in consumption

Question 19

Give an example of positive externalities of consumption

Answer 19

When. a child is immunised against chickenpox, it makes it less likely treat another unimmunised child in the local area will get chickenpox

Question 20

When do negative externalities of consumption occur?

Answer 20

When social benefits < private benefits in consumption

Question 21

Give an example of negative externalities of consumption

Answer 21

With passive smoking, a person twin ego smokes in their home harms the health of others in the home

Question 22

Social costs =

Answer 22

Private cost + External Cost

Question 23

Social Benefit =

Answer 23

Private benefit + External benefit

Question 24

Negative externalities lead to…

Answer 24

over production/consumption = Market failure

Question 25

Positive externalities lead to …

Answer 25

under production/consumption = Market failure

Question 26

Where does price mechanism work efficiently?

Answer 26

If demand = supply at the point where private costs = private benefits

Question 27

What externality does this graph show?

Answer 27

A Negative production externality

Question 28

Explain the graph

Answer 28

• Market equilibrium is at Q1-P1.
• The socially optimum level of production is lower than Q1. It is at Q2 where SMC=SMB.
• If production takes place at Q1, there is welfare loss to society (the difference between the MSC and the MPB. (Total sum of vertical differences between Q1 and Q2).
• This is the deadweight welfare loss triangle.

Question 29

What externality does this graph show?

Answer 29

Negative consumption externality