Ch. 8

• What is an externality in economics?

  A cost or benefit external to a market
• What are private costs?

  Costs incurred by an individual or firm
• What are external costs?

  Costs borne by a third party
• What are social costs?

  The sum of private and external costs
• What are social benefits?

  The sum of private and external benefits
• What are private benefits?

  Benefits received by an individual or firm
• What are external benefits?

  Benefits received by a third party
• What is a production externality?

  An externality affecting the production side
• What is welfare loss?

  Social loss when market equilibrium diverges
• What is market failure?

  A situation where resources are not optimally allocated
• What is a consumption externality?

  An externality affecting the consumption side
• What are common reasons for market failure?

  Externalities, information failure, public goods
• What does it mean for markets to operate rationally?

  Markets operate where supply equals demand
• What is the implication of markets not operating efficiently?

  Too much or too little of a good is produced
• How do externalities affect market transactions?

  They create costs or benefits not reflected in prices
• What is a positive externality of consumption?

  A benefit to a third party from consumption
• What happens when consumers do not account for external benefits?

  Market equilibrium is not at the optimal point
• What is an example of a positive externality of consumption?

  Education benefits society as a whole
• What is a negative externality of consumption?

  A cost to a third party from consumption
• What is an example of a negative externality of consumption?

  Loud music disturbing neighbors at night
• What is an externality of production?

  A cost or benefit to a third party from production