1.3.2 Externalities

• What is market failure due to externalities?

  Market failure occurs when externalities are ignored
• How do markets arrive at equilibrium?

  By considering only private costs and benefits
• What are externalities in economics?

  Spillover effects on society from economic activities
• What do externalities include?

  Both costs and benefits to society
• What does the pure free market reflect?

  Private costs of producers and benefits of consumers
• What is the formula for social cost?

  Social cost = Private cost + external cost
• What is the formula for social benefit?

  Social Benefit = private benefit + external benefit
• What does the full social cost and benefit include?

  Both private and external costs and benefits
• What are third-party effects in economics?

  Effects arising from production or consumption
• Can externalities be positive or negative?

  Yes, they can be both
• What is a positive externality?

  When third parties benefit from an activity
• What is a negative externality?

  When third parties are adversely affected
• What is the socially optimum equilibrium in the context of externalities?

  • The point where social cost equals social benefit
  • Reflects the optimal output level for society
  • Takes into account both private and external factors
• What does the graph of socially optimum equilibrium show?

  Intersection of marginal social cost and benefit
• What does MSC stand for in economic graphs?

  Marginal Social Cost
• What does MSB stand for in economic graphs?

  Marginal Social Benefit
• What does SMPC stand for?

  Social Marginal Private Cost
• What is the significance of external costs in market output?

  They affect the socially optimal output level
• How do external benefits influence market decisions?

  They can lead to underproduction of goods
• What is the equation for calculating the marginal social cost (MSC)?

  MSC = MPC + MEC
• What does MPC stand for?

  Marginal Private Cost
• What does MEC stand for?

  Marginal External Cost
• What does MPB stand for?

  Marginal Private Benefit
• What does MRB stand for?

  Marginal Revenue Benefit
• What happens if there are excessive external costs in the market?

  The market overproduces and underprices goods
• What indicates a market failure in terms of external costs?

  Market price is below socially optimum price
• How do positive externalities cause market failure?

  They lead to underproduction compared to optimum levels
• What is the equation for calculating marginal social benefit (MSB)?

  MSB = MPB + MEB
• What does a low market price indicate in the presence of positive externalities?

  It does not reflect the full social benefit
• What are activities that generate positive externalities?

  • Investment in education and training
  • Health care and medical research benefits
  • Vaccination and immunisation programmes
  • Flood protection systems and fire safety equipment
  • Restored historic buildings and monuments
  • Usage benefits from public libraries and museums
  • Increased innovation
• What is the relationship between market output and socially optimum output when there are excessive external benefits?

  Market output is below socially optimum output
• What does the equation MPC + MCC = MSC represent?

  It represents the marginal social cost
• What does the equation S = MPC signify?

  Supply equals marginal private cost
• What does the equation D = MPB = MSB indicate?

  Demand equals marginal private benefit
• What is the implication of ΔWB = MPB + ΔEB?

  It indicates changes in welfare benefits
• What does Qmkt and Qslo represent in the context of market equilibrium?

  Qmkt is market quantity, Qslo is socially optimum quantity