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AS Revision for June resit exam – Externalities

Here is another video from Phil Holden concerning negative externalities. Remember the following:

Externalities are common in virtually all economic activities. They are defined as third party (or spill over) effects arising from the production and/or consumption of goods and services for which no appropriate compensation is paid.

Externalities can cause market failure if the price mechanism does not take into account the full social costs and social benefits of production and consumption. The study of externalities by economists has become extensive in recent years, not least because of concerns about the link between the economy and the environment.

THE DIFFERENCE BETWEEN PRIVATE AND SOCIAL COSTS

Externalities create a divergence between the private and social costs of production.

SOCIAL COST = PRIVATE COST + EXTERNALITY

* Private costs are the costs to a ‘firm of producing a good or service and to an individual of consuming a product.

* External costs are the spill over effects on third parties.

* Social costs are obtained by adding the private and external costs together. They reflect the total cost to society of an economic decision.