Externalities

Question 1

negative externality of production

Answer 1

– At equilibrium MPB = MPC represents size of the external costs from production of demerit goods

– Spillover cost to 3rd parties (context)

– Triangle represents deadweight loss to society for overproduction of demerit good

– Resources are over produced in the market, and over allocated

– At equilibrium MSC larger than MPC

– FMQ larger than SOQ

– market is allocatively inefficient

– negative externality of production is an example of market failure as resources will be missallocated in the market

Question 2

Negative externality of consumption

Answer 2

– At equilibrium MPB =, MPC represents the size of external costs from consumption of demerit goods

– Spillover cost a third parties

– Triangle represents deadweight loss society over over consumption of the demerit, good

– Resources in the market overallocated and overconsumed

– At equilibrium MPB larger than MSB

– FMQ larger than SOQ

– Welfare loss to society

– Market is allocatively inefficient

– negative externalities of consumption is an example of market failure, as resources are misallocated

Question 3

Positive externality of production

Answer 3

– At equilibrium MPB =, MPC represents the size of external benefits from production of merit goods

– Spillover benefits to 3rd parties

– Triangle represents deadweight loss, and under production of merit goods

– Resources in the market are underproduced

– At equilibrium MPC, larger than MSC

– FMQ Less than SOQ

– Welfare gain

– Market is allocatively inefficient

– Positive externality of production is an example of market failure as resources are misallocated

Question 4

positive externalities of consumption

Answer 4

– At equilibrium MPB = MPC represents size of external benefits from under consumption of merit goods

– Spillover benefits to 3rd parties

– Triangle represents deadweight loss for underconsumption of merit goods

– resources are under allocated and underconsumed

– at equilibrium MSB larger than MPB

– FMQ less than SOQ

– Welfare gain

– Market is allocatively inefficient

– Positive externalities of consumption is an example of market failure as resources are misallocated