Unit 1 January 2012 – Context 2

Question 1.

An external cost can be defined as a cost faced by a third party for which no compensation is forthcoming when producing or consuming a good. If there are any external costs in consuming the good, the social cost will be greater than the private cost. The occurrence of an external cost may lead to market failure. This is because the free market forces generally ignore the external cost. For example, driving a car imposes a private cost to the driver but driving a car also creates a greater social cost for other people (the third party) in society such as; Noise and Air Pollution.
Question 2.

From Extract D, I have observed that the cost of operating a speed camera per site is approximately about £21093. This is higher than the cost of operating per traffic light camera, for which the cost is about £14693.
I have also observed that the annual fine income generated by speed cameras is higher at £6,730,000 than that of the annual fine income generated by traffic light cameras, which is at £1,632,000.
Question 3.

A merit good is a good or service which generally consist of positive externalities that benefit the greater society in general. These good/services are provided by the state as the market forces fail to provide them at an optimal output.
Merit goods are often underprovided because the consumers of these merit goods do not consider the greater social benefit and mostly the private benefit of consuming the good. This means that the positive externalities are not taken into consideration. Therefore the quantity consumed ends up at QP; therefore the marginal private benefit is below the marginal social cost. As the market only produces match the quantity consumed at QP. As a result a welfare lost at ABC is created as the market does not produce at where Marginal Social Benefit equals