Externalities — Edexcel A-Level Economics A
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Externalities explained
Positive externalities of consumption occur when consuming a good benefits third parties whom the consumer does not consider.
Read the full explanation
On a marginal analysis diagram, plot quantity horizontally and benefit and cost vertically. Marginal private benefit (MPB) is the demand curve; marginal external benefit (MEB) is the third-party benefit; adding them vertically gives marginal social benefit (MSB = MPB + MEB), drawn above and to the right of MPB. Marginal social cost (MSC) equals marginal private cost when production has no externality, so MSC is the supply curve. Market equilibrium is where MPB meets MSC, at Qm. The social optimum is where MSB meets MSC, at Qs, with Qs greater than Qm. The welfare gain is the triangular area between Qm and Qs, bounded above by MSB and below by MSC, representing units whose social benefit exceeds social cost.
Your focus
- Construct a marginal analysis diagram showing MPB, MEB, MSB and MSC for a positive consumption externality.
- Identify market equilibrium Qm and social optimum Qs and explain why Qs exceeds Qm.
- Shade and label the welfare gain area between Qm and Qs bounded by MSB and MSC.
Externalities exam tips
Marking Points
- MSB is derived by vertically adding MEB to MPB, so the MSB curve lies above MPB at every quantity where MEB is positive.
- Market equilibrium quantity Qm is found where MPB intersects MSC, because private consumers ignore external benefits.
- Social optimum quantity Qs is found where MSB intersects MSC, and Qs is greater than Qm for a positive consumption externality.
- The welfare gain triangle lies between Qm and Qs, bounded above by MSB and below by MSC, and widens as the gap between MSB and MSC grows.
- Correct axis labelling (quantity; benefit and cost in money terms) and correct curve labels are required for the diagram to communicate the analysis.
Examiner Tips
- 💡Sketch the diagram first, label MPB, MEB, MSB and MSC, then mark Qm and Qs before writing any explanation.
- 💡State the direction of the quantity difference explicitly: Qs exceeds Qm, so the market under-consumes relative to the social optimum.
- 💡When identifying the welfare gain, name its three boundaries (MSB, MSC and the vertical line at Qm) so the examiner can see the area you mean.
Common Mistakes
- Drawing MSB below MPB: the error is treating external benefit as a reduction in benefit; the correction is that MEB is added vertically to MPB, so MSB lies above MPB.
- Locating the social optimum where MSB meets MPB: the error is ignoring costs; the correction is that the social optimum is where MSB meets MSC.
- Shading the whole area under MSB as welfare gain: the error is over-inclusion; the correction is that only the triangle between Qm and Qs, bounded by MSB above and MSC below, is the welfare gain.
- Reversing the quantity comparison: the error is claiming Qm exceeds Qs; the correction is that Qs exceeds Qm because the market under-consumes relative to the social optimum.