Pearson Edexcel · A-Level · Economics B

    Course version: 9EB0 · Version from Sept 2015

    C) Costs and benefits from the production and consumption of goods and…

    Full specification wording

    Market failure and externalities: c) Costs and benefits from the production and consumption of goods and services

    Economic activities generate costs and benefits during the production and consumption of goods and services.

    Checked against the Pearson Edexcel 9EB0 specification (opens in a new tab) on .

    • Point 3 of 5
    • 3 key terms

    Study notes

    From the checked teaching notes for this specification point.

    The idea

    Economic activities generate costs and benefits during the production and consumption of goods and services. Private costs and benefits affect direct participants in a market transaction, like a firm's raw material costs or a consumer's utility. External costs and benefits affect third parties. For example, factory pollution is an external cost of production, while passive smoking is an external cost of consumption. Technological spillovers are external benefits of production, and herd immunity is an external benefit of consumption. Social costs and benefits are the sum of private and external impacts. Market failure occurs when the price mechanism ignores these externalities, leading to a misallocation of resources.

    What earns the marks

    • Define private costs and benefits as those affecting the direct participants in a market transaction.
    • Define external costs and benefits as those affecting third parties not directly involved in the transaction.
    • Calculate social costs as the sum of private and external costs, and social benefits as the sum of private and external benefits.
    • Distinguish between externalities arising from the production of goods and those arising from consumption.
    • Explain how the presence of external costs or benefits leads to market failure and a misallocation of resources.

    Common mistakes and how to put them right

    • Confusing production externalities with consumption externalities.

      Put it right: Production externalities occur when a good is manufactured (e.g. factory emissions), while consumption externalities occur when it is used (e.g. passive smoking).

    • Assuming all costs are financial.

      Put it right: External costs include non-financial negative impacts on third parties, such as noise pollution or health degradation.

    • Equating private costs with social costs.

      Put it right: Social costs are only equal to private costs if there are zero external costs generated by the economic activity.

    Exam tips

    • Clearly specify whether an externality arises from the production or consumption of a good when analysing a scenario.
    • Use the formula 'Social Cost = Private Cost + External Cost' to demonstrate understanding of the relationship between these variables.
    • Always link the existence of external costs or benefits to the concept of market failure and the resulting misallocation of resources.

    Try the lesson

    The start of the Market failure and externalities: c) Costs and benefits from the production and consumption of goods and services lesson, made from checked teaching notes for this specification point.

    Have a go first

    Which of the following is an example of an external cost arising specifically from the production of a good?

    Listen

    Economic activities generate costs and benefits during the production and consumption of goods and services. Private costs and benefits affect direct participants in a market transaction, like a firm's raw material costs or a consumer's utility. External costs and benefits affect third parties. For example, factory pollution is an external cost of production, while passive smoking is an external cost of consumption. Technological spillovers are external benefits of production, and herd immunity is an external benefit of consumption. Social costs and benefits are the sum of private and external impacts. Market failure occurs when the price mechanism ignores these externalities, leading to a misallocation of resources. A strong answer earns marks for these points. Define private costs and benefits as those affecting the direct participants in a market transaction. Define external costs and benefits as those affecting third parties not directly involved in the transaction. Calculate social costs as the sum of private and external costs, and social benefits as the sum of private and external benefits. Distinguish between externalities arising from the production of goods and those arising from consumption. A common slip: Confusing production externalities with consumption externalities. Instead, production externalities occur when a good is manufactured (e.g. factory emissions), while consumption externalities occur when it is used (e.g. passive smoking). Exam tip: Clearly specify whether an externality arises from the production or consumption of a good when analysing a scenario.

    See it

    A top-down flowchart. The top node, costs and benefits of production and consumption, splits into two branches: private costs and benefits, and external costs and benefits. The private branch leads to a node saying they affect direct participants in a market transaction. The external branch leads to a node saying they affect third parties, and also to four nodes: external costs of production, external costs of consumption, external benefits of production, and external benefits of consumption. The direct-participants node and the external branch both feed into a node stating social costs and benefits equal private plus external. That leads to a node saying the price mechanism ignores externalities, which leads to the final node, market failure and misallocation of resources.
    It shows how private and external costs and benefits combine into social costs and benefits, and how ignored externalities lead to market failure.

    Key words

    Say what each word means before you turn the card.

    Externalities

    Try answering aloud or in your head before turning the card.

    Market failure

    Try answering aloud or in your head before turning the card.

    Social costs and benefits

    Try answering aloud or in your head before turning the card.

    See every definition
    Externalities
    Costs and benefits from economic activities that affect third parties not directly involved in the transaction.
    Market failure
    Occurs when the price mechanism ignores externalities, leading to a misallocation of resources.
    Social costs and benefits
    The sum of private and external impacts from the production and consumption of goods and services.

    Label the diagram

    Some boxes have lost their names. Pick the right name for each number.

    The diagram again, with 3 boxes numbered instead of named. A top-down flowchart. The top node, costs and benefits of production and consumption, splits into two branches: private costs and benefits, and external costs and benefits. The private branch leads to a node saying they affect direct participants in a market transaction. The external branch leads to a node saying they affect third parties, and also to four nodes: external costs of production, external costs of consumption, external benefits of production, and external benefits of consumption. The direct-participants node and the external branch both feed into a node stating social costs and benefits equal private plus external. That leads to a node saying the price mechanism ignores externalities, which leads to the final node, market failure and misallocation of resources.

    • 1Box 1

    • 2Box 2

    • 3Box 3

    0 of 3 labelled

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