Environmental Concerns: Externalities (Cambridge (CIE) O Level Business Studies)

The Impact of Business Activity on the Environment

• Business activity often has a range of impacts on the natural environment

• In many cases, businesses consider the pursuit of profit to be more important than protecting the environment 

• Socially responsible businesses often choose to limit negative impacts and sometimes take steps to make a positive impact on the natural world

The Effects Businesses can have on the Environment

Externalities

• Externalities occur when there is an external impact on a third party not involved in the business transaction between the buyer and the seller

  • These impacts can be positive or negative and are often referred to as spillover effects

  • These impacts can be on the production side of the market (producer supply) or on the consumption side of the market (consumer demand)

Private, external and social costs

• External costs occur when the social costs of a business transaction are greater than the private costs

  • A private cost for the business, consumer or government is what they actually pay to produce or consume a good/service e.g. a consumer pays $9 for a McDonald's meal

  • An external cost is the damage not factored into the business transaction, e.g. the consumer throws their McDonalds packaging onto the street and the Government has to hire cleaners to collect the litter

• The social cost includes both the private cost and the cost to society

  • It is a better reflection of the true cost of a business transaction

  • Social cost = private cost + external cost 

Private, external and social benefits

• External benefits occur when the social benefits of a business transaction are greater than the private benefits

  • A private benefit for a consumer, producer or government is what they actually gain from producing or consuming a good/service e.g. a bee farm gains the private benefit of the income from selling their honey

  • An external benefit (positive externality) is the benefit not factored in to the business transaction, e.g. The bees from the bee farm pollinate the nearby apple orchards

• The social benefit includes both the private benefit & the external benefit to society

  • It is a better reflection of the true benefit of an economic transaction

  • Social benefit = private benefit + external benefit 

Examples of Private Costs & Benefits

Private Costs and Benefits of a Decision to Launch a New Product

Examples of External Costs and Benefits

• Private costs and benefits do not account for negative or positive impacts on wider society

External Costs and Benefits of a Decision to Launch a new Product

• Where a businesses plans require external approval such as planning permission from government, the overall social costs and benefits are often weighed up

  • If social benefits are greater than social costs the businesses plans are likely to be approved

  • If social costs are greater than social benefits the businesses plans are likely to be rejected

Controls over Business Activity Affecting the Environment

• Businesses impact on the environment can be controlled by governments, which can legislate or take enforcement action against those that break environmental laws

• Governments can choose to

  • Change laws to make environmentally-damaging practices illegal, such as

    • Prohibit the location of certain businesses in environmentally sensitive areas, such as rainforests

    • Outlaw the dumping of hazardous waste into waterways

    • Banning the use of hazardous materials in manufacturing processes and packaging

• Impose fines on businesses that break environmental regulations and order them to clean up environmental damage

• Impose limits on business activities that cause environmental damage

  • Pollution permits allow businesses to pollute up to a certain limit

  • If more pollution is produced a business must purchase extra permits from the government or from a more environmentally-friendly business