Pearson Edexcel · A-Level · Economics B
Course version: 9EB0 · Version from Sept 2015
B) The impact on society of charging prices that do not reflect total…
Full specification wording
Externalities: b) The impact on society of charging prices that do not reflect total internal and external costs
When prices only reflect internal costs (private costs) and ignore external costs, the market fails to allocate resources efficiently, causing a negative impact on society.
Checked against the Pearson Edexcel 9EB0 specification (opens in a new tab) on .
- Point 2 of 3
- 3 key terms
Study notes
From the checked teaching notes for this specification point.
The idea
When prices only reflect internal costs (private costs) and ignore external costs, the market fails to allocate resources efficiently, causing a negative impact on society. For example, if a chemical plant produces plastic but dumps toxic waste into a local river, the price of the plastic only covers the firm's internal costs like labour and raw materials. It does not include the external cost of cleaning the river or the health impacts on local residents. Because the total social cost is higher than the private cost, the product is underpriced and overproduced. This overconsumption leads to a misallocation of resources and a deadweight welfare loss to society, as the cost to society of producing the last units exceeds the benefit.
What earns the marks
- Identification of the difference between private costs (internal) and social costs (internal plus external).
- Explanation that prices failing to reflect external costs lead to overproduction and overconsumption of the good.
- Recognition that this mispricing results in a misallocation of resources and market failure.
- Identification of the deadweight welfare loss to society caused by the overproduction.
- Application of the concept to a specific market scenario, such as manufacturing pollution.
Common mistakes and how to put them right
Confusing internal costs with external costs.
Put it right: Internal costs are paid by the producer (e.g. wages), while external costs are borne by third parties (e.g. pollution).
Assuming that a price not reflecting total costs always means the price is too high.
Put it right: When negative externalities exist, the market price is actually too low because it ignores the external costs.
Stating that external costs only affect the government.
Put it right: External costs affect society as a whole, including local residents, other businesses, and future generations.
Exam tips
- Always define social cost as the sum of private (internal) costs and external costs when discussing market failure.
- Use a clear, real-world example of a negative externality to illustrate how underpricing leads to overconsumption.
- When evaluating the impact on society, explicitly mention the concept of deadweight welfare loss and resource misallocation.
Try the lesson
The start of the Externalities: b) The impact on society of charging prices that do not reflect total internal and external costs lesson, made from checked teaching notes for this specification point.
Have a go first
A pesticide manufacturer charges a market price that covers its labour and material costs but ignores the negative external costs of chemical runoff into local rivers. What is the most likely impact on society of charging this price?
Listen
When prices only reflect internal costs (private costs) and ignore external costs, the market fails to allocate resources efficiently, causing a negative impact on society. For example, if a chemical plant produces plastic but dumps toxic waste into a local river, the price of the plastic only covers the firm's internal costs like labour and raw materials. It does not include the external cost of cleaning the river or the health impacts on local residents. Because the total social cost is higher than the private cost, the product is underpriced and overproduced. This overconsumption leads to a misallocation of resources and a deadweight welfare loss to society, as the cost to society of producing the last units exceeds the benefit. A strong answer earns marks for these points. Identification of the difference between private costs (internal) and social costs (internal plus external). Explanation that prices failing to reflect external costs lead to overproduction and overconsumption of the good. Recognition that this mispricing results in a misallocation of resources and market failure. Identification of the deadweight welfare loss to society caused by the overproduction. A common slip: Confusing internal costs with external costs. Instead, internal costs are paid by the producer (e.g. wages), while external costs are borne by third parties (e.g. pollution). Exam tip: Always define social cost as the sum of private (internal) costs and external costs when discussing market failure.
See it
Put it in order
Put these steps in the order they happen.
- 1. Deadweight welfare loss to society
- 2. Misallocation of resources
- 3. Total social cost higher than private cost
- 4. Overproduction and overconsumption
- 5. Price reflects only internal costs
- 6. External costs ignored
- 7. Product underpriced
Key words
Say what each word means before you turn the card.
Market failure
Try answering aloud or in your head before turning the card.
Resource allocation
Try answering aloud or in your head before turning the card.
Social welfare
Try answering aloud or in your head before turning the card.
See every definition
- Market failure
- A situation where the market fails to allocate resources efficiently, as when prices ignore external costs.
- Resource allocation
- The way resources are distributed, which becomes a misallocation when prices do not reflect total internal and external costs.
- Social welfare
- The wellbeing of society, which suffers a deadweight welfare loss when the cost of producing the last units exceeds the benefit.
Label the diagram
Some boxes have lost their names. Pick the right name for each number.
1Box 1
2Box 2
3Box 3
There is more to this lesson
The full lesson goes on to check your understanding and help you earn the marks. Create a free account to carry on, with your progress saved.
A week of Premium from your first lesson · Then the free plan continues · No card, no charge
Test your understanding of Externalities: b) The impact on society of charging prices that do not reflect total internal and external costs
Active recall beats re-reading. Take an instant quiz now to test what you’ve learned and lock it into long-term memory.
A week of Premium from your first lesson · Then the free plan continues · No card, no charge