Externalities | A-Level Economics Model Paragraph (AQA, Edexcel, OCR)

Negative Externalities in Consumption

The diagram shows a market failure (misallocation of resources) with fast food.

Fast food is a demerit good as it has negative externalities in consumption.

This means there is a cost to a third party (anyone apart from the buyer or the seller) when fast food is consumed.

For example, consumers of fast food would have worse health and this would be a burden on the NHS which is funded by taxpayers.

The diagram shows that fast food is over-consumed at q1 because the externalities are ignored by the free-market.

The socially optimal quantity is qs if we were to account for the externalities.

The government can intervene to solve the market failure.

Positive Externalities in Consumption

The diagram shows a market failure (misallocation of resources) with gym memberships.

The gym has positive externalities in consumption.

For example, consumers of the gym would have better health and this

have a positive impact on the third party as gym-goers will be healthier and more productive - overall benefit to society e.g. taxpayer/ employers.

The diagram shows that gym memberships are under-consumed at q1 because the externalities are ignored by the free-market.

The socially optimal quantity is qs if we account for the externalities.

The government can intervene to solve the market failure.

Negative Externalities in Production

The diagram shows a market failure (misallocation of resources) with magazines.

Magazines have negative externalities in production.

For example, magazines are produced using paper, which means cutting down trees. This impacts the environment and therefore is a burden on the third party (people apart from the buyer and seller).

The diagram shows that magazines are over-produced at q1 because the externalities are ignored by the free-market.

The socially optimal quantity is qs, if we account for the externalities.

The government can intervene to solve the market failure.

Positive externalities in production

The diagram shows a market failure (misallocation of resources) with honey.

Honey has positive externalities in production.

For example, beekeepers produce honey which they can sell, but keeping keeping bees. they are helping out neighbouring farmers by pollinating their crops.

The diagram shows that honey is under-produced at q1 because the externalities are ignored by the free-market.

The socially optimal quantity is qs, if we account for the externalities.