Externalities

Introduction
• Market failure is a situation in which the price system creates a problem
for society or fails to achieve society’s goals.
• Market failure occurs
• Externalities
• Public Goods
 Externalities
• Externality: one type of market failure, the impact of one
person’s actions on the well-being of another person.
• Externalities can be negative or positive:
 If the impact on the bystander is adverse, it is called a negative externality.
 If it is beneficial, it is called a positive externality.
 Types of externalities

Production negative externalities

Production positive externalities
Consumption negative externalities
Consumption positive externalities
 1. Production Negative Externalities

Negative
production
externalities occur
when the
production
process results in
a harmful effect
on unrelated
third parties
 2. Production Positive Externalities
Positive production externalities occur when the act of production
leads to lower costs to other (third party) agents in the economy.

The construction and operation of an

airport will benefit local businesses
Pollination of because of the increased
surrounding crops accessibility.
by the bees.
A foreign firm that demonstrates up-
to-date technologies to local firms
and improves their productivity.

An industrial company providing first

aid classes for employees to increase
workplace safety. This may also save
lives outside the factory.
 Consumption Negative Externalities

Negative
consumption
externalities are
costs to third
parties arising
from the
consumption of
goods and
services
 4. Consumption Positive Externalities

A positive
consumption
externality
occurs when
consuming a
good cause a
positive
spillover to a
third party lying
outside the
transaction.
 Government Intervention

• Correct negative externalities

• Direct controls
• Specific taxes
• Correct positive externalities
• Subsidies
• Government provision

LO4 5-9
1. What type of externality is evident from the picture below?

a) Negative consumption externality

b) Positive consumption externality
c) Negative production externality
d) Positive production externality
1. What type of externality is evident from the picture below?

a) Negative consumption externality

b) Positive consumption externality
c) Negative production externality
d) Positive production externality

Answer: C, This pollution is an external cost as the cost is borne by people other than
the factory polluting. This means that pollution is a negative production externality.
2. What type of externality is evident from the picture below?

a) Negative consumption externality

b) Positive consumption externality
c) Negative production externality
d) Positive production externality
2. What type of externality is evident from the picture below?

a) Negative consumption externality

b) Positive consumption externality
c) Negative production externality
d) Positive production externality

Answer: b, This attractive sculpture in someone's garden will have external benefits
as other can also enjoy it.
3. What type of externality is evident from the picture below?

a) Negative consumption externality

b) Positive consumption externality
c) Negative production externality
d) Positive production externality
3. What type of externality is evident from the picture below?

a) Negative consumption externality

b) Positive consumption externality
c) Negative production externality
d) Positive production externality
Answer: a, A negative consumption externality is one that leads to external costs. Smoking
is a consumption activity and results in costs being imposed on those other than just the
people smoking (health costs etc). It is therefore a negative consumption externality.
4. What type of externality is evident from the picture below?

a) Negative consumption externality

b) Positive consumption externality
c) Negative production externality
d) Positive production externality
4. What type of externality is evident from the picture below?

a) Negative consumption externality

b) Positive consumption externality
c) Negative production externality
d) Positive production externality
Answer: c, The gasholder leads to an external cost for this house (and people passing by)
and arises from a production activity.
5. What type of externality is evident from the picture below?

a) Negative consumption externality

b) Positive consumption externality
c) Negative production externality
d) Positive production externality
5. What type of externality is evident from the picture below?

a) Negative consumption externality

b) Positive consumption externality
c) Negative production externality
d) Positive production externality
Answer: a, A negative consumption externality is one that leads to external costs.
The external costs here are arising from the consumption activity of buying and
using cars for transport.
6. The image below shows syringes used for vaccination. What type of externality is
evident from this?

a) Negative consumption externality

b) Positive consumption externality
c) Negative production externality
d) Positive production externality
6. The image below shows syringes used for vaccination. What type of externality is
evident from this?

a) Negative consumption externality

b) Positive consumption externality
c) Negative production externality
d) Positive production externality
Answer: b, Vaccination will lead to external benefits as it will protect other from
catching diseases.
7. Which of the following activities create a negative externality?

A) cleaning up the sidewalk on your block

B) graduating from college
C) repainting the house you live in to improve its appearance
D) keeping a junked car parked on your front lawn
7. Which of the following activities create a negative externality?

A) cleaning up the sidewalk on your block

B) graduating from college
C) repainting the house you live in to improve its appearance
D) keeping a junked car parked on your front lawn

Answer: D
Thank You