Edexcel A Level Economics A:复习笔记1.3.2 Externalities

Externalities & Different Types of Costs

  • Externalities occur when there is an external impact on a third party not involved in the economic transaction
    • These impacts can be positive or negative and are often referred to as spillover effects
    • These impacts can be on the production side of the market (producer supply) or on the consumption side of the market (consumer demand)
  • External costs occur when the social costs of an economic transaction are greater than the private costs
    • A private cost for the producer is what they actually pay to produce a good/service
    • An external cost (negative externality) is the damage not factored in to the economic activity (for example, generating air pollution when producing electricity)
    • Private cost + external cost = social costs
  • External benefits occur when the social benefits of an economic transaction are greater than the private benefits
    • A private benefit for the consumer is what they actually gain from consuming a good/service
    • An external benefit (positive externality) is the benefit not factored in to the economic activity (for example, someone who studies law enjoys private benefits but society benefits from having strong legal institutions)
    • Private benefit + external benefit = social benefits

External Costs of Production

  • Negative externalities of production are often created during the production of a good/service
  • The market is failing due to over-provision of these goods/services as only the private costs are considered by the producers and not the external costs
    • If the external costs were considered, the quantity of the goods/services provided would decrease and they would be sold at a higher price
  • Marginal analysis in economics considers the cost or benefit of the next unit produced or consumed
    • The marginal private cost (MPC) is the cost of the next unit produced or consumed
    • The marginal private benefit (MPB) is the benefit derived from the production or consumption of the next unit

1-3-2-externalities_1_edexcel-al-economics

External costs of production (negative externality) result in an over-provision shown by the gap between Qopt and Qe

 

Diagram Analysis

  • The marginal social benefit (MSB) is assumed to be equal to the marginal private benefit (MPB) as the focus is on the producer side of the market
  • The free-market equilibrium can be seen at PeQe. This is where the MPC = MSB
  • The larger the external costs in production, the larger the gap between the MPC and the marginal social cost (MSC)
  • The optimal allocation of resources from society’s point of view, would generate an equilibrium where MSB = MSC. This can be found at PoptQopt. There is no market failure at this equilibrium
  • The free market is failing due to over-provision of this good/service at Qe
  • The factors of production used to manufacture this over-provision represent a welfare loss to society (pink triangle)
  • To be socially efficient, fewer factors of production should be allocated to producing this good/service
  • There is an opportunity for government intervention (indirect taxes, legislation, regulation etc.), to force this market to be more socially efficient
  • Any intervention that reduces the welfare loss will be beneficial

External Benefits of Consumption

  • Positive externalities of consumption are created during the consumption of a good/service (merit goods)
  • The market is failing due to under-consumption of these goods/services as only the private benefits are considered by the consumers and not the external benefits
    • If the external benefits were considered, the quantity of the goods/services consumed would increase and they would be sold at a higher price

1-3-2-externalities_2_edexcel-al-economics

External benefits of consumption (positive externality) result in an under-consumption represented by the gap between Qe and Qopt

 

Diagram Analysis

  • MSC is assumed to be equal to the MPC as the focus is on the consumer side of the market
  • The free-market equilibrium can be seen at PeQe. This is where the MPB = MSC
  • The larger the external benefits in consumption (positive externality), the larger the gap between the MPB and MSB
  • The optimal allocation of resources from society’s point of view would generate an equilibrium where MSB = MSC. This can be found at PoptQopt. There is no market failure here
  • The free market is failing due to an under-consumption of this good/service at Qe
  • More factors of production should be allocated to producing the optimal quantity as societal welfare will be gained (pink triangle)
  • There is an opportunity for government intervention (subsidies, partial provision etc.) to force this market to be more socially efficient
  • Any intervention that gains welfare will be beneficial

Exam Tip

Your understanding of externalities is frequently examined in MCQ.  You will be asked questions in language which can seem confusing, such as:

  • MSC is greater than MSB at free market equilibrium
  • The free-market quantity is less than the social optimum quantity
  • Increasing output will lead to a net welfare gain

It is intentionally confusing as there is only one right answer. Work through the options step by step and apply your theory and one option will stand out. That is the correct answer!

The Impact of Externalities & Government Intervention in Different Markets

  • Analysing externalities and the government intervention necessary to correct them is best done by considering real world examples
  • Analysis should always include the impact on stakeholders including producers, consumers, government, and relevant third parties

The Impact of Negative Externalities & Government Intervention

Example External Costs Possible Stakeholders Government Intervention
 

Extraction of iron ore (mining)

 

  • Soil erosion
  • Loss of habitat for species
  • Decrease in air quality
  • Chemical leakage into the water table
 

  • Producers (Miners)
  • Manufacturers who purchase iron ore
  • Environment
  • Community who live nearby
  • Government
  • Special interest groups e.g. environmental pressure groups such as Greenpeace
 

  • Indirect taxation
  • Legislation & regulation, enforcement through fines
  • Any intervention has both advantages and disadvantages e.g. decreasing the external costs may decrease output which may decrease economic growth

 

The Impact of Positive Externalities & Government Intervention

Example External Benefits Possible Stakeholders Government Intervention
 

Leisure Centres

 

  • Healthy people require less state medical care
  • Relieves stress & increases productivity in the workplace
  • Older people maintain independence for longer and less of a burden on family/state
  • Improves memory and concentration which raises productivity in the workplace
  • Improves relationships and helps others to be more productive
 

  • Leisure Centre Owners
  • Consumers (Members)
  • Community who live nearby
  • Government
  • Local health services
  • Employers
  • Economy
 

  • Increase provision
  • Subsidise existing provision
  • Advertise to raise awareness of benefits
  • Any intervention has both advantages and disadvantages e.g. subsidising Leisure Centre memberships may reduce funding available for libraries

 

 

 

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