Externalities | A-Level Economics Notes

These revision notes cover everything you need to know about Externalities for A-Level Economics. They're designed for students studying AQA A-Level Economics, Edexcel A-Level Economics, and Edexcel International A-Level Economics. Written by Jaisul Naik, UCL Economics graduate and A-Level Economics tutor since 2017.

What is an externality?

An externality is a cost/benefit to a third party, from a transaction.

What is a third party?

A third party is anyone apart from the buyer or the seller.

What causes externalities to happen in a free market?

1. In a free market, externalities get ignored by buyers and sellers.
2. This means that goods and services get over-consumed or under-consumed or over-produced or under-produced.
3. This causes market failure.

What is a negative externality in consumption?

1. A negative externality in consumption occurs when the consumption of a good or service has a negative impact on a third party.
2. A third party is someone apart from the buyer or the seller.
3. For example, when someone regularly eats unhealthy fast food, their health worsens, which means they are likely to put more burden on the NHS, and therefore taxpayers.
4. However, in a free market, these externalities are likely to be ignored.
5. This means that fast-food is over-consumed in a free market.

What is a positive externality in consumption?

1. A positive externality in consumption occurs when the consumption of a good or service has a negative impact on a third party.
2. A third party is someone apart from the buyer or the seller.
3. For example, when someone regularly goes to the gym, their health improves, which means they are likely to have less burden on the NHS, and therefore taxpayers.
4. However, in a free market, these externalities are likely to be ignored.
5. This means that gym memberships are under-consumed in a free market.

What is a negative externality in production?

1. A negative externality in production occurs when the production of a good or service has a negative impact on a third party.
2. A third party is someone apart from the buyer or the seller.
3. For example, the production of newspapers means there is an increase in paper usage, which means an increase in deforestation. This causes environmental damage which affects people other than the buyer or the seller.
4. However, in a free market, these externalities are likely to be ignored.
5. This means that newspapers are over-produced in a free market.

What is a positive externality in production?

1. A positive externality in production occurs when the production of a good or service has a positive impact on a third party.
2. A third party is someone apart from the buyer or the seller.
3. For example, beekeepers produce honey but this also has a benefit that is passed onto nearby farmers, in terms of pollination.
4. However, in a free market, these externalities are likely to be ignored.
5. This means that honey is under-produced in a free market.

Summary questions

1. what is an externality?
2. what is a third party?
3. what causes externalities to happen in a free market?
4. what is a negative externality in consumption?
   1. definition
   2. example
   3. diagram
   4. analysis
5. what is a positive externality in consumption?
   1. definition
   2. example
   3. diagram
   4. analysis
6. what is a negative externality in production?
   1. definition
   2. example
   3. diagram
   4. analysis
7. what is a positive externality in production?
   1. definition
   2. example
   3. diagram
   4. analysis

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