4.1.8.4 Positive and negative externalities in consumption and production Quiz: AQA Economics, Unit 1

The 20 questions

1. An externality exists when:

   • The government sets a price floor above equilibrium, so that suppliers are paid more than the market rate for each unit.
   • Firms earn supernormal profit in the long run, because barriers to entry prevent new firms from competing in the market.
   • Private costs and social costs are exactly equal, so the market price fully reflects all costs of an activity in the economy.
   • There is a divergence between private and social costs or benefits of an economic activity, so third parties are affected.

2. A factory releases smoke that harms nearby residents' health, and the firm does not pay for this damage. What type of externality is this?

   • A negative externality of consumption, because the residents themselves choose to consume the smoke released by the factory.
   • A positive externality of consumption, because residents enjoy a benefit from the factory's output in their daily lives.
   • A positive externality of production, because the firm's output provides a benefit to the residents living close to the factory.
   • A negative externality of production, because the costs of pollution fall on third parties not included in the firm's costs.

3. Why do negative externalities typically result in over-production?

   • Producers face lower costs than they would otherwise, so they are encouraged to raise prices and reduce output in the market.
   • Consumers gain benefits from the good that are not captured by the producer, so they buy too little of the good in the market.
   • Producers ignore the external costs, so the market price is lower than the social cost and too much output is supplied.
   • The government always subsidises producers of polluting goods, so their output is pushed above the efficient level in every case.

4. Why do positive externalities typically result in under-production?

   • Consumers are charged a price above marginal social benefit, so they buy too much of the good in the market each year.
   • The external benefits are always captured by the producer through higher prices, so output is always efficient in the market.
   • Producers do not receive payment for the external benefits, so the market supplies less than the socially efficient quantity.
   • Producers receive payment for every external benefit, so they are encouraged to reduce output below the efficient level.

5. Which is an example of a positive externality of consumption?

   • Vaccination, because a person who is vaccinated reduces the risk of infection for other people in the community.
   • Smoking in a public place, because the smoke affects the health of others who are nearby and do not choose to inhale it.
   • Excess noise from a nightclub, because local residents suffer disturbance from the activity during the night-time hours.
   • Traffic congestion, because drivers add to delays experienced by other road users during peak travel periods of the day.

6. Which is an example of a negative externality of production?

   • Training provided by a firm to its employees, which raises the skills of workers who then move to other employers in the area.
   • Carbon emissions from a power station, which impose costs on communities through climate and pollution effects not paid by the firm.
   • A flower garden planted by a homeowner, which gives pleasure to passers-by who walk along the street outside the house.
   • A new motorway built by the government, which reduces journey times for road users and raises the value of nearby homes.

7. A factory's private marginal cost is £4 per unit and the external cost is £2 per unit. What is the social marginal cost?

   • £8 per unit, being the private marginal cost multiplied by the external cost, which captures the total cost of production.
   • £2 per unit, being the external cost alone, since the private cost is paid by the firm and so is not counted.
   • £4 per unit, because the social cost always equals the private cost whenever the firm pays the production costs itself.
   • £6 per unit, being the sum of private marginal cost and external marginal cost.

8. Which policy would correct a negative externality by raising the private cost of the activity?

   • A subsidy paid to producers for each unit they supply, which lowers the firm's costs and so increases output further.
   • A reduction in income tax paid by the firm's workers, which increases their disposable income and so raises demand in the case described.
   • A maximum price set below equilibrium, which lowers the price consumers pay and so encourages consumption of the good.
   • An indirect tax, such as a carbon tax, which raises the firm's marginal cost towards the level of the social marginal cost.

9. Which policy would encourage consumption of a good with a positive externality?

   • An indirect tax levied on each unit consumed, which raises the price paid by consumers and reduces demand for the good.
   • A ban on all consumption of the good, which removes any choice and so always raises the welfare of people in the economy.
   • A maximum price set below equilibrium, which makes the good more expensive for consumers and so reduces the quantity bought.
   • A subsidy paid per unit consumed, which lowers the effective price to consumers and increases demand towards the efficient level.

10. Which is the best reason why the absence of property rights leads to externalities?

    • Without clear ownership, no one can charge for the use of a resource, so users ignore the costs they impose on others.
    • Without ownership, the government always charges the full social cost of each use of the resource to every user.
    • With clear ownership, each owner must share the benefit of the resource with all other users in the economy at no charge.
    • With clear ownership, the resource is always over-used by its owner, because the owner has no reason to conserve the resource.

11. A government grants pollution permits that can be traded. What is the main aim of this policy?

    • To set a cap on total pollution and allow the market to price the right to pollute, internalising the external cost.
    • To subsidise firms that pollute, so that they can afford to install cleaner technology without changing their output at all.
    • To transfer the ownership of polluting firms to the state, so that the government sets the output level directly for each firm.
    • To remove all pollution from the economy immediately, so that firms are forced to cease all production that creates emissions.

12. An externality affects third parties. Which of the following is a positive externality of production?

    • Noise from a construction site, which disturbs residents living close to the site during working hours each weekday.
    • Carbon emissions from a steel mill, which impose health costs on people living near the mill in the surrounding area.
    • Training provided by a firm, which raises the skills of workers who may later work for other employers in the local area.
    • Traffic congestion caused by lorries, which slows journeys for all drivers using the same roads at peak times in the case described.

13. Which evaluation point suggests that taxing a negative externality may not fully correct the market failure?

    • Taxes raise no revenue for the government, so they cannot be used to fund any measures that reduce the external costs.
    • The tax may be difficult to set at the correct level, because the size of the external cost is hard to measure precisely.
    • Taxes always remove negative externalities completely, because the firm's costs rise by exactly the amount of the external cost.
    • Taxes affect only consumers and never producers, so the firm's output decisions are unaffected by the tax in any case.

14. A firm's output generates external costs. Which statement describes the efficient outcome?

    • Output is where marginal private benefit equals marginal private cost, which is above the output the market produces.
    • Output is where price equals average cost, which is always above the efficient level of output in every market.
    • Output is maximised, because the firm produces as much as it can to satisfy demand regardless of the costs imposed.
    • Output is where marginal social benefit equals marginal social cost, which is below the output the market produces.

15. Which is a positive externality of consumption from education?

    • A rise in the price of education, which reduces the number of places available to students in the local community in the case described.
    • A fall in the wages of graduates, which reduces the incomes of all workers who have completed secondary schooling.
    • An increase in the cost of school buildings, which raises the amount the government must spend on public services.
    • Higher civic participation and lower crime rates in the community, which benefit people who did not pay for the education.

16. Which statement about the Coase style solution to externalities is most accurate?

    • Clear property rights and low bargaining costs may allow those affected to negotiate a solution without government intervention.
    • Bargaining always fails when property rights are clear, so the government must intervene in every externality case in the case described.
    • Bargaining has no effect on externalities, because the price mechanism alone always internalises external costs and benefits.
    • Bargaining works only when there are very many parties, so a small number of affected people can never reach agreement.

17. The market for a good with a positive externality has an output below the efficient level. Which policy best corrects this?

    • A per-unit subsidy equal to the external benefit, which shifts the private supply curve towards the social supply curve.
    • An indirect tax on the good equal to the external benefit, which raises the price consumers pay and so reduces demand.
    • A ban on the sale of the good, which forces all consumers to buy substitutes that have no external benefits at all.
    • A maximum price set below the equilibrium price, which lowers the cost of the good to consumers and reduces output further.

18. Which is a negative externality of consumption?

    • Use of a public library, which gives benefits to the wider community through the availability of knowledge and learning.
    • Ownership of a well-maintained garden, which improves the view for people walking past the house in the street.
    • Vaccination against a contagious disease, which protects people who are not themselves vaccinated in the community.
    • Second-hand smoke from a smoker, which harms the health of nearby non-smokers who do not choose to inhale it.

19. Which is the best example of a positive externality of production?

    • A loud late-night party that disturbs sleeping neighbours next door, who have no say in whether the party takes place.
    • Heavy lorry traffic that damages a local road used by other drivers, who receive no compensation for the repairs needed.
    • A chemical plant discharging waste that kills fish in a river used by anglers further downstream from the plant site.
    • A beekeeper's bees pollinating neighbouring farms, which raises their crop yields without any payment from the farmers.

20. A firm's negative externality is ignored by its managers. What is the consequence for total welfare?

    • Total welfare is higher, because the firm produces more output than the efficient level without any cost to society at all.
    • Total welfare is unchanged, because the external cost is paid by third parties and so cancels out in the national accounts.
    • Total welfare is lower than it would be if the external cost were internalised, because output exceeds the efficient level.
    • Total welfare falls to zero, because the external cost always exceeds the total value of the output produced by the firm.

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