Negative externalities/external costs

1. Fill in the missing words.

Negative externalities can be described as ______________ _________ to a third party not
involved in the original economic transaction. It can be calculated by the formula
_________________ cost minus __________________ cost. Private plus ____________
costs is equal to ___________ cost. The area on the diagram representing welfare
(deadweight) loss is represented by the area where _____ > __________. Negative
externalities are generally associated with the production and consumption of
_____________ goods.

2. Plotting a negative externality

Americans enjoy beef, it is estimated that the average US citizen consumes 3 beef burgers
each week but the production of cattle is associated with many external costs e.g.
Methane production and the use of fertilisers and pesticides created from some of the
intensive farming methods employed.

On the graph paper, plot the following data to illustrate this situation.

No of Beef Private benefit Private cost Social cost

burgers /Social benefit
1 £52 £16 £40
2 £44 £20 £44
3 £36 £24 £48
4 £28 £28 £52
5 £20 £32 £56

a. At the market-determined level of

output, how many burgers will be
produced?
______________________________
b. At the socially optimal level of
output, how many burgers should be
produced?
_______________________________
c. How large is the external cost
associated with each burger?
____________________________
d. Shade in the area of welfare loss.

e. If the government imposes a tax on

meat equal to the external cost of producing it, this is said to ______________________ the
externality, by making the MSC=MPC.
f. Suggest two alternative policies that the US government might employ to reduce the negative
externality associated with beef farming?

3. Examples
Identify private and external costs/benefits associated with the following examples.
• The provision of technical education for young school leavers
• The construction of a metro line within a large city
• Consumption of alcohol and tobacco products.

4. Graphical Analysis
Using a correctly labelled externality diagram show the impact of the London cycling super
highway, constructed in 2010, on cyclists in the city. It is estimated to have saved many
hundreds of lives (among cyclists) in the city, as well as diverted many thousands of car
drivers away from the roads.

a. On the diagram identify the socially optimal level of output and the market determined
level of output.
b. Shade in the area of welfare loss.