Cambridge International as and a level Economics Ebook

1 
Identify examples of
■
private 
costs
■
external 
costs
that have resulted from the chemical spillage.
2 
Explain the problems of putting monetary values on 
these costs.
3 
How might the costs of the externalities be 
internalised on Freedom Industries?
4 
Discuss what measures might be put in place to 
ensure that such a spillage does not occur in the 
future.
air quality. Th
ese negatively impact on third parties such 
as residents and pedestrians. For road users, the speed of 
traffi
c falls below the optimum, causing delays to all road 
users (see Self-assessment task 8.2). Another example 
is the case of passive smoking and its eff ects on non-
smokers; there is also the problem of aircraft noise, which 
can seriously aff ect the lifestyles of people who live close 
to a major airport, many of whom may never travel by air.
Figure 8.6
shows these situations. Because of 
the external costs, MSB is below MPB. Th
e market 
equilibrium, however, is at 
P
1 
and 
Q
1
where MPB = MPC. 
Th
e social optimum is below this at 
Q
0
, where MSB 
and MPC intersect. Market failure can be corrected by 
imposing an indirect tax on those who have caused the 
negative consumption externality. Th
e supply curve shift s 
to the left ; if the tax is the same as the external cost, then 
the quantity traded will fall to 
Q
0
. Allocative effi
ciency will 
now be achieved.
Legislation is also widely used in these situations. Th
ere 
are strict laws in place that prohibit smoking in public 
buildings, close to schools, in restaurants, shopping malls, 
railway stations and so on. Th
ere are regulations in place in 
many countries that put noise and time restrictions on when 
aircraft can take off and land. Th
e noise from vehicles is also 
subject to strict regulations in most developed economies.
Figure 8.6 
Negative consumption externalities
P
2
P
1
0
Price
Quantity
Tax
Q
1
Q
0
MSB
D
= MPB
S
= MPC
S
= MPC + MEC