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?

Externalities are the spillover effects from a transaction, on a third party.

What is a third party?

A third party is anyone apart from the producer or consumer.

What causes externalities to happen in a free market?

1. In a free market, externalities get ignored by buyers and sellers due to self-interest.
2. This means that goods and services get over-consumed or under-consumed or over-produced or under-produced.
3. This means that there is a market failure as there is a misallocation of resources.
4. Social welfare is not maximised.

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. 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. In a free market, these externalities are likely to be ignored.
5. This means that gym memberships are under-consumed in a free market.