Correcting externalities, and who they affect

Overview

Recall questions on why externalities cause market failure, the interventions used to correct them, and the economic agents affected.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   In a diagram showing external costs of production, what does the MPC curve represent?

   Model answer

   The MPC curve represents the costs to the producer.

2. 2

   How is the external cost per unit shown on a diagram with MPC and MSC curves?

   Model answer

   The vertical distance between the MSC and MPC curves represents the external cost per unit.

3. 3

   Why does the MSC curve lie above the MPC curve when there are external costs of production?

   Model answer

   Because MSC includes both the private costs to the producer and the external costs imposed on third parties, making total social costs higher than private costs alone.

4. 4

   Where does market equilibrium occur in terms of private costs and benefits?

   Model answer

   Market equilibrium occurs where marginal private cost equals marginal private benefit, reflecting decisions based only on private costs and benefits.

5. 5

   What output level represents the social optimum?

   Model answer

   The output level where marginal social cost equals marginal social benefit, representing the quantity that maximises welfare for society.

6. 6

   What happens to output when external costs of production exist?

   Model answer

   The market equilibrium quantity exceeds the socially optimal quantity, resulting in overproduction.

Other ways to work this

The same content, four other ways.

What is inside Levo

Six ways to work the same material.