Negative Externalities of Production and Consumption
Market Failure: Externalities and Common Pool Resources
AO2·AO4·Diagram required
Syllabus requirement
Situations where third parties incur costs not reflected in market prices, resulting in overproduction of demerit goods.
Assessment objectives
AO2 Application and AnalysisAO4 Use of Appropriate Skills
Required diagram: Diagrams showing market failure due to negative externalities (of production and consumption), with MSC > MPC or MSB < MPB and welfare loss triangle.
Summary
This topic explains negative externalities that arise when production or consumption imposes costs on third parties not involved in the market transaction. It distinguishes private and social costs and benefits, shows how social costs exceed private costs when negative externalities exist, and why markets produce a welfare loss unless corrected. Diagrams normally show MPC < MSC (production) or MSB < MPB (consumption) with a welfare-loss triangle.
