Question 4 (ii)
Externality, and why social cost exceeds private cost under a negative externality
4 marks
- Time to write
- About 8 minutes
- Topic
- Externalities
Question
Question 4 (ii) · 4 marks- What is meant by an Externality? Explain in what way the Social Cost of a good exceeds the private cost when a negative externality is present?
Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- What is meant…?Explain…?2 asks, each with its own marks below. Answer both.
Write it in this order
- Read; underline the asks; jot your points 1 min
- 1 Meaning of an externality, positive and negative 1½ marks 3 min
- 2 Why social cost exceeds private cost under a negative externality 2½ marks 4 min
Easy marks
- Step 1 opens with the meaning: a one-line definition, the quickest mark in it.
Short on time? Trim steps 1 and 2 evenly rather than skip one: each is capped at its own marks.
Try it first. About 8 minutes for 4 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Meaning of an externality. An externality is the effect, good or bad, that the action of a firm or a person has on others who are not party to it, for which the one acting is neither paid nor penalised; no market exists in which the effect is bought or sold. It is negative when the effect harms others (a refinery that pollutes a river and cuts the fishermen's catch, with the refinery bearing no cost for it) and positive when it benefits others who pay nothing for the benefit.
- Private cost is the cost the producer itself pays to make the good: wages, raw materials, power, rent and the rest.
- Social cost is the full cost to society of making the good: the private cost plus the external cost, the damage the production does to others that the producer does not pay for.
Why social cost exceeds private cost. When a negative externality is present, part of the cost of production falls on people outside the transaction. The producer decides how much to produce by looking only at what it pays, so the harm to others is left out of its cost. Social cost is private cost plus that external cost, and the external cost is positive, so social cost is greater than private cost at every level of output. The gap between the two is exactly the external cost per unit.
Example (our own). A brick kiln near a village in Haryana pays ₹4 a brick for clay, coal and labour; that is its private cost. Its smoke damages crops and the villagers' health, a loss we may value at ₹1 a brick. The social cost of a brick is then ₹5, but the kiln prices and plans its output on ₹4.
Consequence for the market. Since producers decide on private cost alone, the market supply curve reflects private cost, not social cost. The market therefore produces more of the good, at a lower price, than is best for society: units are made whose social cost exceeds the value buyers place on them. This is why a negative externality is a source of market inefficiency.
Where the 4 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Meaning of an externality, positive and negative | 1.5 |
| 2 | Why social cost exceeds private cost under a negative externality | 2.5 |
| Total | 4 |
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