Externalities: exam-style questions
Written in the style of A-level papers. 34 marks. Work on screen and open the answers as you go, or print a copy.
Section A: multiple choice
1A negative externality in production means that: [1]
- marginal social cost is greater than marginal private cost
- marginal private cost is greater than marginal social cost
- marginal social benefit is greater than marginal private benefit
- marginal private benefit is greater than marginal social cost
Answer
A. MSC = MPC + marginal external cost. A cost to third parties makes MSC higher than MPC.
2The socially optimal level of output is where: [1]
- marginal social benefit equals marginal social cost
- marginal private benefit equals marginal private cost
- marginal social cost is at its lowest
- marginal external cost is zero
Answer
A. At MSB = MSC, the value to society of the last unit equals its full cost to society.
3Which of these is the clearest example of a positive consumption externality? [1]
- A person being vaccinated against flu
- A person smoking in a crowded bus shelter
- A factory releasing waste into a river
- A monopoly raising its prices
Answer
A. Vaccination lowers the chance that others catch the illness: a benefit to third parties from consumption.
4Where a negative production externality causes overproduction, the welfare loss is the area: [1]
- between MSC and MSB, from the social optimum to the market output
- between MPC and MSC, from zero to the market output
- below MSB, from zero to the social optimum
- between MPB and MPC, from zero to the market output
Answer
A. Each unit beyond the optimum costs society more than it is worth to society; the triangle between MSC and MSB adds up those losses.
5To reach the social optimum, a tax to correct a negative externality should be set equal to: [1]
- the marginal external cost at the social optimum
- the marginal private cost at the market output
- the market price at the social optimum
- the total external cost at the market output
Answer
A. A tax equal to the marginal external cost at the optimum makes firms face the full social cost at that output.
Section B: data and short answer
The table shows marginal benefits and costs for flights from a regional airport. Marginal social benefit equals marginal private benefit. Noise and pollution create a constant external cost for every flight.
| Flights per day | Marginal private benefit, £ | Marginal private cost, £ | Marginal social cost, £ |
|---|---|---|---|
| 100 | 800 | 200 | 400 |
| 200 | 700 | 300 | 500 |
| 300 | 600 | 400 | 600 |
| 400 | 500 | 500 | 700 |
| 500 | 400 | 600 | 800 |
6Identify the free market number of flights and the socially optimal number of flights. [2]
Mark guidance
- Free market: 400 flights a day, where MPB = MPC = £500 (1 mark)
- Social optimum: 300 flights a day, where MSB = MSC = £600 (1 mark)
7State the marginal external cost of a flight. [1]
Mark guidance
- £200 a flight (MSC − MPC) (1 mark)
8Calculate the welfare loss each day from the free market number of flights. Show your working. [2]
Mark guidance
- At 400 flights, MSC is £700 and MSB is £500, a gap of £200; the loss is a triangle over 100 flights (1 mark)
- ½ × 100 × £200 = £10,000 a day (1 mark)
9Explain why the free market produces more flights than the social optimum. [3]
Mark guidance
- Airlines and passengers decide on private costs and benefits only (1 mark)
- They ignore the £200 external cost borne by local residents (1 mark)
- So flights between 300 and 400 go ahead even though their cost to society is greater than their benefit (1 mark)
10State the tax per flight that would bring the market to the social optimum. [1]
Mark guidance
- £200 per flight, equal to the marginal external cost (1 mark)
Section C: extended answer
11Evaluate the view that taxation is the most effective way to correct a negative externality. [20]
Mark guidance
A typical split is knowledge 6, application and analysis 6, evaluation 8; check your own board’s scheme.
Analysis could include
- A tax equal to the marginal external cost shifts MPC up to MSC, internalising the externality
- Output falls to the social optimum and the welfare loss is removed
- The polluter pays, and the revenue can fund cleaning up or compensating third parties
- Firms keep an incentive to find cleaner methods to reduce what they pay
Evaluation could include
- Measuring the external cost in money is hard, so the tax is likely to be set too high or too low
- If demand is price inelastic, the tax raises revenue but cuts output little
- Taxes can be regressive and hurt low-income households most
- Alternatives: regulation and bans (certain but inflexible), tradable permits (a fixed cap on pollution), subsidies for cleaner substitutes
- The best tool depends on the externality: for a dangerous pollutant a ban may be better than a price
Levels
Top band: a range of points developed in full chains of reasoning, applied to the context, with judgements that are weighed and supported ("it depends on..."). Middle band: some developed chains but evaluation is one-sided or asserted. Bottom band: points listed or described without chains, little or no evaluation.