Theme 1.3 - Externalities Flashcards
What is an externality?
Spill over effects from production/consumption for which no appropriate compensation is paid
External cost - beyond market value
Why do externalities cause market failure?
Price mechanism does not take account of social C+B of prod + cons
Market value does not reflect true cost to society
When does a negative externality emerge?
Social costs > private costs
Why does a negative externality emerge?
Transaction results in negative side effects for innocent third party
Why do negative externalities result in market failure?
Demerit goods overproduced + consumed
Market price ≠ SOP (External costs)
Results in welfare loss
What is the difference between private + social costs?
P - Financial costs to firm
S - Total cost to society (Includes Ext.)
Why are externalities an issue within the free market?
(By and large) Free market ignores external costs
When does a positive externality emerge?
Social benefit > Private benefit
Why does a positive externality emerge?
Transaction results in beneficial effects for innocent third party
Why are positive externalities an example of market failure?
Merit goods overpriced
Consumption too low
Welfare gain
What is welfare gain?
Societal benefit that is lost by ignoring positive externalities
