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1. A2 Economics and BusinessTo what extent are externalities acceptable? Unit 4b

   Mrs Hilton for revisionstation
2. Lesson Objectives To be able to describe cost benefit analysis To be able to apply this to the case study
3. Starter Two lists – what are the costs and benefits of obesity?
4. Worksheet
5. Social costs The social costs of any product is the sum of the private costs (i.e. the normal costs of production) and the external costs – if there are any - which fall on other people. SOCIAL COST = PRIVATE COST + EXTERNAL COST In the case of food consumption, the private cost would be the cost of buying the food. The external cost would include the cost of NHS care if food was eaten to excess, causing illness.
6. Social benefits Equally, the social benefits of any product are the sum of the private benefits that the individual gets through eating responsibly and the external benefits – if there are any – which other people receive. SOCIAL BENEFITS = PRIVATE BENEFITS + EXTERNAL BENEFITS It is the presence of significant external benefits which makes a good a merit good – or, in the absence of corresponding private benefits, a public good. Taken together, external costs and external benefits are known as externalities.
7. Negative externality? An externality is an indirect consequence of an economic activity that is experienced by unrelated third parties Therefore a negative externality is social costs minus private costs More social costs than private costs (spillover effect)
8. How do externalities affect an economy? They can lead to market failure. In the case of an industry that generates significant external costs, under free market conditions it will grow to above its optimal size. On the other hand in the case of an industry that generates significant external benefits the industry will, under free market conditions, be below its optimal size. So in the case of food, we might expect the free market to produce too much high-fat, processed foods and too few fruit and vegetables.
9. Examples of externalities, economic, environmental and social Another way of looking at externalities is to ask on whom the externality falls. If it falls on other businesses, it is sometimes referred to as an economic externality if on neighbours as a social externality if the impact is first felt by the natural environment then an environmental externality
10. Example
11. Difficulty in measuring externalities Private costs and benefits are relatively easy to measure. Companies employ accountants to work out their private costs. Consumers who shop regularly develop a fairly clear idea of how much something is worth to them, i.e. their private benefit. However externalities are spread out over a much wider population, and attempts to express their cash value have to be treated with caution. For example, the external costs of obesity include the costs to the taxpayer of the increased operations the NHS has to perform. However, should we deduct the costs of the care obese people would have received if they had lived longer but for their condition?
12. Impact of externalities in short versus long run In the case of obesity the immediate impact of people putting on excess weight is relatively minor, but the impact several decades later may be substantial. Or again, it may not. In the case of both climate change and obesity, there is always the possibility that some advance in technology will fix the problem at much lower cost than we can see today. Link to article
13. To what extent are externalities acceptable? The assumption behind this question is that we are dealing with external costs, rather than external benefits. No-one is going to object to an external benefit! The fact that a good or service generates an external cost in either its production or consumption is not a reason to prohibit the good altogether. This is particularly true in the case of obesity where the underlying product – food – is essential to human life. Indeed, the whole point of taxing demeritgoods is not to reduce their consumption to zero. Rather, it is to reduce their consumption to the efficient level. Video on merit demerit goods
14. Cost – benefit analysis 1 When a private company is making a decision about whether to undertake any new commercial venture, it will weigh up the potential financial gains against the costs – and then compare the potential return with other possible projects. In other words, private costs will be compared with private benefits. In the absence of significant externalities, this process works well for the whole of society as well as the individual company. Since the potential financial gains reflect an estimation of how many consumers are prepared to pay for the product – and how much - what works for the company works for all of us.
15. Cost benefit analysis 2 Governments, however, do not normally get involved in purely commercial decisions. A decision to build a hospital or grant planning permission for an extra terminal at Heathrow demands assessment of where the public interest lies. In these cases, a decision is normally made after trying to weigh up externalities, as well as the private costs and private benefits that a commercial company would recognise. This exercise is known as ‘cost-benefit analysis’. Wight loss surgery (gastric bands etc) is one form of treatment where cost-benefit analysis would be relevant. The potential costs and benefits of the procedure for patients with different BMIs have to be weighed up, and decisions made within the context of the overall limit on the amount of health expenditure the government feels it can afford.
16. Plenary (from the spec) How much of an externality should we accept? Can we use decision making tools such as cost-benefit analysis to help here? Are they effective?
17. For your conclusions some “it depends” http://www.dailymail.co.uk/femail/article-2555117/Morbidly-obese-veterinary-secretary-BMI-65-loses-weight-baby-elephant-liquid-diet.html Doesn’t always have to be surgery above http://www.dailymail.co.uk/health/article-2555204/Weight-loss-surgery-patients-likely-dependent-alcohol.html Surgery can lead to other problems http://www.mirror.co.uk/news/bizarre-nhs-gastric-band-u-turn-1816090 Happier fat!
18. Sample question 1 What is meant by the term “social benefit”? [2]
19. Answer question 1 Knowledge up to 2 marks: A valid definition of social benefit e.g.privatebenefits plus positive externalities.
20. Sample question 2 Explain why emissions from vehicles is a negative externality? [4]
21. Answer question 2 Knowledge and understanding 1 mark: Some valid understanding of negative externality e.g. “social costs minus private costs” (1 mark) Application 1 mark: Carbonmonoxide/smoke/ other emissions (1 mark) Analysis up to 2 marks: Polluted air contributes to health problems (1 mark) the treatment of which has to be paid for by the tax payer (1 mark)
22. Sample question 3 Briefly explain two externalities of alcoholic drinks consumption. [5]
23. Answer question 3 Knowledge 2, Application 2, Analysis 1 Knowledge up to 2 marks: An externality is an indirect consequence of an economic activity (1 mark) that is experienced by unrelated third parties (1 mark). Or an externality can be either positive or negative (1 mark). Application up to 2 marks: In this case, negative externalities include costs to the NHS (1 mark) and by extension society at large (1 mark). Another externality is the impact on those innocently caught up in scuffles (1 mark). Analysis 1 mark: E.g. according to the evidence, one positive externality is lower health costs due to the apparent benefits of moderate drinking.
24. Sample question 4 Explain one social benefit that may result from road transport [4]
25. Answer question 4 Knowledge 1, Application 1, Analysis 2 Knowledge and understanding 1 mark: Socialbenefits are the positive effects on society of an economic decision/e.g. employment/government revenue (1 mark) Application 1 mark: Quicker deliveries/lower transport costs/ wide range of goods available/easier travel to friends and relatives (1 mark) Analysis: Up to 2 marks Quicker deliveries to supermarkets help to reduce costs (1 mark) which can be passed on to the consumer as lower prices (1 mark)