This is the final exam for Externalities. It pulls together everything: the precise definition (a real cost or benefit on a third party, outside the price), the master split of private vs. social cost and private vs. social benefit, why negative externalities cause over-production and positive ones cause under-production, the deadweight-loss triangle in both directions, the worked marginal-cost numbers, and the whole repair kit — Pigouvian taxes and subsidies, cap-and-trade, regulation, and the Coase theorem — with where each one fails. Several questions look easy until you spot the trap: mislabeling a price-mediated effect as an externality, forgetting the positive half, blessing the market’s quantity by using private instead of social cost, or reaching for one universal cure.
How this exam works
Read carefully — this exam is final. Each question appears one at a time. Once you submit an answer it is locked for good: there’s no going back, no retry, and no restart. Your score is hidden until the end, where you’ll see a pass/fail verdict. The pass mark is 70%. A few questions ask you to select all correct answers.
What is the cleanest definition of an externality?
Select an answer to continue.
Course Recap
Big picture
Externalities, in one picture
- Externalities
- The definition
- A real cost or benefit on a third party, outside the price — so private cost/benefit ≠ social cost/benefit, and the price stops telling the truth. Not the same as a pecuniary effect, a cost you pay yourself, or something you just dislike.
- Negative → over-production
- A cost dumped on others (pollution, traffic, noise, antibiotic resistance) lifts marginal social cost above private cost; the market makes too much, and the triangle between demand and MSC is welfare destroyed.
- Positive → under-production
- A benefit spilled onto others (vaccines, education, research, beekeeping) lifts marginal social benefit above private; the market makes too little, and the triangle is welfare forgone. The half everyone forgets.
- The repair kit
- Internalize: Pigouvian taxes/subsidies (price the spillover in), cap-and-trade (fix quantity, float price), regulation (mandate the outcome), and Coase (clear rights + cheap bargaining → private fix).
- Choosing the tool
- No panacea: match the fix to the externality (parties, rights, measurability, severity) — and often blend. Coase for few parties; tax/cap for many; bans where the right amount is ~zero. The commons is this engine at scale.
- The definition
Key takeaways
An externality is a real cost or benefit that lands on a third party outside the transaction and escapes the price — so the private cost the decider weighs isn’t the social cost the world bears, and the market lands on the wrong quantity. A negative externality (pollution, traffic, antibiotic resistance) lifts marginal social cost above private cost and makes the market over-produce, burning a deadweight-loss triangle of destroyed welfare. A positive externality (vaccines, education, research) lifts marginal social benefit above private and makes the market under-produce — the same triangle as welfare forgone, and the half almost everyone forgets. Every fix internalizes the spillover — drags it into the decider’s price: Pigouvian taxes and subsidies price it per unit, cap-and-trade fixes the quantity and floats the price, regulation mandates the outcome, and the Coase theorem shows clear rights plus cheap bargaining can fix it privately — until the parties get too many and the rights too fuzzy, which is every big externality. There’s no single cure: read the spillover and match, or blend, the remedy to it.