DIPLOMA IN BUSINESS STUDIES

ABBE3033 BUSINESS ECONOMICS

TUTORIAL 3: Externalities

Question 1 ( August 2015/16)

(a) Using appropriate examples, distinguish between a ‘positive’ and a ‘negative’ externality.
(6 marks)

(b) (i) Using an appropriate diagram, illustrate a negative production externality. (4

marks)

(ii) Describe how the above externality leads to market inefficiency. (5 marks)

(c) Explain briefly how tradable pollution permits are used to internalise externalities such as
pollution. (5 marks)
[Total: 20 marks]

Question 2 ( March 2014/2015)

(a) Using appropriate examples, explain the difference between a negative and a positive
consumption externality. (6 marks)

(b) (i) Using an appropriate diagram, illustrate a negative consumption externality. (3 marks)

(ii) Explain how a negative consumption externality reduces the welfare of the society.
(5 marks)

(c) Explain how corrective taxes are used to internalise negative production externalities that cause
pollution. (4 marks)
[Total: 20 marks]

Question 3 ( April 2013/2014)

(a) According to doctors, exercise not only makes us feel better and looks younger but it also makes
us less likely to fall sick. Based on the statement above:

(i) Identify the type of externality. (2 marks)

(ii) Draw a diagram to show the externality described in part (i) above. (4 marks)

(iii) Describe how the above externality leads to inefficiency. (4 marks)

(b) (i) Explain Coase theorem with an example. (4 marks)

(ii) Describe THREE (3) reasons why Coase theorem may fail. (6 marks)
[Total: 20 marks]

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Question 4 (Dec 2011/Jan 2012)

(a) Residents of Taman Bunga Raya complain that almost every day, they cannot get out of their
houses because TARC students park their cars outside their gates.

(i) Identify and explain briefly the type of externality caused by parking. (4 marks)
(ii) Illustrate the situation by using an appropriate diagram. (4 marks)
(iii) Explain briefly how the externality leads to market inefficiency. (4 marks)

(b) Define “ Coase Theorem” and state when is it used. (4 marks)

[Total: 20 marks]

Question 5 (September 2016/17)

Villagers See Red Over Bauxite Dust

KUANTAN: Every time it rains, the sea near the Kuantan Port turns red – but it is not a strange sight for
residents of Kampung Selamat who have to live with dust from bauxite mining.

Villager Abdul Razak Ngah, 43, said the sea would be “stained red” with pollution each time there was
heavy rain.

“There are hills of (bauxite) ore in the port area near our village. The wind will blow the red dust
everywhere and when it rains, the water washes the dust down the drain and into the sea.

“The sea gets so red sometimes that it is like a sea of blood,” he said here yesterday.

Abdul Razak said the problem was made worse by lorries transporting the ore to the port.

“The lorries now have to take a detour to enter the port. But when the ore has been unloaded, dust on the
vehicles get blown everywhere when they pass by our village to exit,” he said.

Fellow villager Faidah Jusoh, 47, said the dust had worsened her asthma and makes her skin itch.

“I have to go to the clinic at least three times a month to get my health checked. It was not always like
this. The ore transportation to the port only intensified over the past year,” she said.

Faidah, who runs a stall by the road, said she had to cover her food each time a lorry passed by due to
the dust. Her assistant Siti Sandora, 43, said despite complaints to their village chief, authorities had yet
to provide a long-term solution.

“I have to wipe my house furniture and mop the floor several times a day,” she said.

Source: Adapted and modified from Koo,S and Ong HS 2015, ‘Villagers see red over bauxite dust’,
STAR 16 May, p.29.

Required:

(a) Based on the case study above, identify and explain the type of externality. (4 marks)

(b) (i) Using an appropriate diagram, illustrate the above externality. (4 marks)
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 (ii) Explain how the above externality can cause market inefficiency. (4 marks)

(c) (i) Describe the purpose of corrective taxes and explain how the amount of corrective taxes
that must be paid by the firm is determined. (4 marks)

(ii) Discuss how a firm decides whether to pay more or less corrective taxes when it
pollutes. (4 marks)
[Total: 20 marks]

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