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All 20 Flashcards — Externalities and Market Failure
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Question
What is a negative externality?
Answer
A cost imposed on a third party who did not choose to incur it. Example: factory pollution causing respiratory disease in nearby residents.
💡 Hint
External = outside the transaction
Question
What is market failure?
Answer
When the free market fails to allocate resources efficiently because environmental costs are not included in prices, leading to overproduction of harmful goods.
💡 Hint
Market ignores environmental costs
Question
What does it mean to "internalise an externality"?
Answer
Making the polluter pay the full social cost of their actions, so the market price reflects the true cost to society including environmental damage.
💡 Hint
Put the hidden cost into the price
Question
Link: externality → market failure → internalisation.
Answer
Negative externalities mean environmental costs are hidden → market overproduces pollution → internalisation puts costs into prices → corrects the failure.
💡 Hint
Hidden cost → broken market → fix price
Question
What is a positive externality?
Answer
A benefit received by a third party not involved in a transaction. Example: a beekeeper's bees pollinating nearby farms for free.
💡 Hint
Positive = bonus benefit to others
Question
Carbon tax vs cap-and-trade: key difference?
Answer
Carbon tax: fixed price per tonne, predictable cost, uncertain reduction. Cap-and-trade: fixed total emissions, guaranteed reduction, but volatile price.
💡 Hint
Tax = fixed price. Cap = fixed quantity.
Question
What makes something a "public good"?
Answer
Non-excludable (cannot prevent people using it) AND non-rivalrous (one person's use doesn't reduce availability). Examples: clean air, stable climate.
💡 Hint
Non-excludable + non-rivalrous
Question
Name five methods to internalise externalities.
Answer
1) Pollution taxes (carbon tax). 2) Subsidies for clean alternatives. 3) Cap-and-trade. 4) Direct regulation. 5) Property rights for commons.
💡 Hint
Tax, subsidise, cap, regulate, own
Question
Why is climate change the ultimate market failure?
Answer
CO2 emissions have no price. Producers and consumers don't pay the true social cost, so fossil fuels are overproduced and overconsumed.
💡 Hint
CO2 has no price tag
Question
What is the free rider problem?
Answer
When individuals or nations benefit from a public good without contributing to its provision. This leads to underfunding of environmental protection.
💡 Hint
Use without paying
Question
How does a carbon tax internalise the externality of climate change?
Answer
It adds a fee per tonne of CO2 emitted, making fossil fuels more expensive to reflect their true social cost, incentivising switch to cleaner energy.
💡 Hint
Price on carbon = incentive to change
Question
What is "social cost"?
Answer
Private cost + external cost = the true total cost to society of producing a good, including environmental damage.
💡 Hint
Social = private + external
Question
Give four examples of negative environmental externalities.
Answer
1) Air pollution → respiratory disease. 2) Agricultural runoff → eutrophication. 3) Carbon emissions → climate change. 4) Noise pollution → reduced property values.
💡 Hint
Air, water, climate, noise
Question
Name five environmental public goods.
Answer
1) Clean air. 2) Stable climate. 3) Biodiversity. 4) Ozone layer. 5) Ocean fish stocks (partially rivalrous — common pool resource).
💡 Hint
Air, climate, bio, ozone, fish
Question
Why are ocean fish a common pool resource, not a pure public good?
Answer
Non-excludable (hard to prevent fishing) BUT rivalrous (one catch reduces stock). This makes them vulnerable to overexploitation — tragedy of the commons.
💡 Hint
Can't exclude + use reduces stock = commons
Question
What is cap-and-trade and how does it work?
Answer
Government sets a total limit (cap) on emissions. Companies get/buy permits. Those who reduce below their limit sell surplus permits. Total emissions controlled with flexibility.
💡 Hint
Cap = limit. Trade = buy/sell permits.
Question
How does overfishing illustrate the tragedy of the commons?
Answer
Each fleet maximises its own catch (self-interest), but collectively this depletes stocks beyond sustainable levels, harming all fishers and the ecosystem.
💡 Hint
Individual gain → collective loss
Question
How do renewable energy subsidies correct market failure?
Answer
Subsidies reduce clean energy costs, making it competitive with fossil fuels whose prices don't include environmental damage. This corrects the pricing failure.
💡 Hint
Make clean option cheaper
Question
How does the tragedy of the commons link to market failure?
Answer
Shared resources have no price in the market, so they are overexploited. The market fails because it does not account for the cost of depleting the commons.
💡 Hint
No price tag on nature = overuse
Question
In exams, what must you explain about a negative externality?
Answer
WHO bears the external cost and HOW they are affected. Show the chain: activity → pollution → third party impact.
💡 Hint
WHO pays and HOW?
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Topic 9.2 hub
Environmental Economics
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