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Externalities refer to the positive or negative effects on other individuals (third parties) during consumption or production. It occurs when the cost/benefit to society is misaligned with the cost/benefit to the individual. If we take smoking as an example, the (marginal) private benefit for cigarette consumption (i.e. utility gains from smoking), is higher than the (marginal) social benefit. This is because the government, as a third party, might have to allocate more resources on medication for smokers and bear their burden. As a result, there will be a negative consumption externality as cigarettes are overconsumed by individuals, but society (e.g. government) would like smokers to consume less.
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Externalities MC Questions with answers (GCE A-Level)
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