External Costs and Benefits

Which of the following statements best describes market failure?

• Resource allocation that does not maximise welfare in society

• Widening income inequality

• Resources are not being used efficiently in society

• Demand does not equal supply in a market

Which of the following statements is not true about negative externalities?

• Society can experience a welfare loss because of them

• Pollution from a factory often causes negative externalities

• They result in an under-allocation of resources

• MSC is greater than MSB at the market output

Answer explanation

Negative externalities cause an over-allocation of resources.

Which of the following goods or services is the most likely to lead to negative externalities of consumption?

• Mobile phones

• Solar panels

• An art gallery

• Organic vegetables

Answer explanation

Mobile phones have consumption and production negative externalities associated with them.

In the diagram, which of the following is not true?

• Arrow A is the external cost

• The consumer and producer surplus are not maximised at point C

• Point D is the socially efficient output

• Supply equals marginal private cost at B

Answer explanation

 The market is in equilibrium (D = S) at point C, so the consumer and producer surpluses are maximised.

What is the best description of the welfare loss associated with a negative externality? It is the:

• Range of output where MSC < MSB

• Point where MPC = MPB

• Range of output where MSC > MSB

• Point where MSB = MSC

Answer explanation

The welfare loss of a negative externality occurs when MSC > MSB

Which of the following goods and services is the least likely to be associated with significant consumption positive externalities?

• Measles vaccine

• New primary school

• Cinema

• Hospital

Answer explanation

Cinemas may be associated with some positive externalities but they will not be as significant as the other options

Which of the following is untrue in the diagram?

• There is an under allocation of resources

• It shows negative consumption externalities

• The consumer and producer surplus are maximised at output Q

• The welfare loss is the yellow triangle

The diagram shows the market for a good.

• External cost

• Producer surplus

• External benefit

• Consumer surplus

Answer explanation

The difference A and B at output Q is where MSB is greater than MPB and this is the external benefit.

The external benefits of healthcare affect third party individuals outside those people who directly benefit from the healthcare they consume. This means the:

• Marginal social benefit is greater than marginal private benefit

• Marginal social cost equals marginal social benefit

• There are no negative externalities of consumption 

• The market for healthcare is at the socially efficient level

Answer explanation

When there are external benefits of consumption it means social benefits are greater than private benefits.

The data shows the forecasted costs and benefits of building a new bridge:

Private costs $150m

External costs $40m

Private benefits $130m

External benefit $20m

From the data, it can be concluded that:

• Social benefits are greater than the social costs

• Social costs are greater than the social benefits

• Society would be better off if the bridge was built

• Social benefit equal $20m

Answer explanation

Social costs ($150m + $40m = $190m) is greater than the social benefits ($130m + $20m = $150m)