Question

Suppose that producing a bicycle generates no environmental degradation, while buying and riding a bicycle (consumption) help reduce greenhouse gas emissions. In contrast, producing, buying and driving a car do generate greenhouse gas emissions. Based on this information, for each economic activity, first discuss whether there is externality and what type of externality it is and explain why(e.g., production/consumption of cars/bicycles leads to positive/negative/no production/consumption externality because … … …). When explaining your reasoning, make sure you relate your specific answer to the definition of externalities. Then, for each economic activity given above (e.g., production/consumption of cars/bicycles), compare private costs and benefits with the true cost and benefit to society.

Answer 1

There are 4 types of economic activities here:

1. Producing a bicycle - Since producing a bicycle generates no environmental degradation, so there is no externality associated with it.
2. Consuming a bicycle - Since buying and riding a bicycle, helps in reducing greenhouse gas emissions, so there is an externality associated with it. Since the consumption of bicycle generates benefit for the third party, so it creates positive externality. In this case, the private cost is higher than the social cost and private benefit is lower than social benefit.
3. Producing a car - Since producing a car generates greenhouse gas emissions, so it generates a negative externality to the society because it incures cost to third party in terms of negative impacts of green house gas. So here the private cost is lower than the social cost and private benefit is higher than the social benefit.
4. Consuming a car - Buying and driving a car also generates greenhouse gas emissions and pollutes the environment incurring cost to the other people, hence a negative externality is associated with it. So in this case also the private cost is lower than the social cost and private benefit is higher than social benefit.