Understanding market failure: Externalities

Overview

Recall questions on Externalities.

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

   Why are externalities considered a form of market failure?

   Model answer

   Externalities impose costs or benefits on third parties not involved in the transaction, causing the market to produce at a quantity other than the socially efficient level.

2. 2

   What are externalities?

   Model answer

   Externalities are costs or benefits that affect third parties who are not directly involved in the production or consumption of a good.

3. 3

   What are external benefits of consumption?

   Model answer

   External benefits of consumption occur when the consumption of a good creates positive spillover effects for third parties.

4. 4

   What are external costs of consumption?

   Model answer

   External costs of consumption occur when the consumption of a good imposes negative spillover effects on third parties.

5. 5

   What are external costs of production?

   Model answer

   External costs of production occur when the production of a good imposes negative spillover effects on third parties.

6. 6

   State the formula for social benefit.

   Model answer

   Social Benefit = Private Benefit + External Benefit.

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