Syllabus: Pearson - AS Level Economics
Module: 1.3 Market Failure
Lesson: 1.3.2 Externalities

Introduction

This lesson focuses on 1.3.2 Externalities, part of the Pearson Edexcel AS Level Economics A specification (Theme 1: Introduction to Markets and Market Failure). It’s designed to help students understand why free markets sometimes fail to deliver efficient outcomes, particularly when third parties are affected by economic activity.

By tackling this topic, students build skills in applying marginal analysis, interpreting welfare implications, and evaluating policy interventions — all of which tie into broader assessment objectives and real-world decision-making. This section also connects directly to later themes on government intervention and efficiency.

Key Concepts

According to the Pearson AS Level syllabus, students must understand:

• Externalities: The spillover effects of economic activity on third parties not directly involved in the transaction.

• Private vs. External vs. Social Costs/Benefits:

  • Private cost: direct cost to producers or consumers.

  • External cost: cost borne by third parties (e.g. pollution).

  • Social cost = private cost + external cost.

  • Private and external benefits follow the same logic.

• Welfare Diagrams:

  • Use marginal analysis to show the gap between market equilibrium and the socially optimal level.

  • Identification of welfare loss (for negative externalities) and welfare gain (for positive externalities).

• Market Failure: Occurs when the market fails to allocate resources efficiently due to externalities.

• Government Intervention: Needed when markets alone don’t internalise these external costs or benefits.

Real-World Relevance

Externalities show up in nearly every major policy debate:

• Pollution: A textbook example. In 2024, the UK extended its Clean Air Zones, charging vehicles that contribute to poor air quality — a direct attempt to price in the external costs of car emissions.

• Vaccinations: Offer strong positive externalities. The government often steps in to subsidise these due to their wider public health benefits.

• Electric vehicles (EVs): EV subsidies and infrastructure investment reflect an attempt to reduce negative externalities from petrol/diesel cars while encouraging positive spillovers like cleaner air and innovation.

These examples help students see how economic theory underpins real government decisions and why “invisible hand” markets can’t always go it alone.

How It’s Assessed

Assessment aligns with Pearson’s A Level approach to application and evaluation:

• Paper 1 will test these concepts within microeconomic contexts using a mixture of:

  • Data response questions (e.g. interpreting a diagram showing welfare loss)

  • Short-answer questions (e.g. define social cost)

  • Extended responses (evaluate whether government intervention improves outcomes in a given market).

• Command words to prep for include:

  • Explain (e.g. external benefits)

  • Analyse (e.g. the effects of under-consumption)

  • Evaluate (e.g. government subsidies vs regulation)

  • Draw/Label diagrams (MSB/MPB, MSC/MPC comparisons)

Practising past papers is vital. Encourage learners to annotate questions for command words and structure responses around logical chains of reasoning and relevant diagrams.

Enterprise Skills Integration

Externalities offer a natural bridge into core enterprise capabilities:

• Problem-Solving: Analysing how markets fail to deliver optimal outcomes builds critical thinking.

• Decision-Making: Evaluating government responses mirrors business strategy — balancing costs, benefits, and stakeholder impact.

• Communication: Interpreting graphs and articulating welfare implications fosters clear, purposeful expression.

• Systems Thinking: Encourages students to consider interdependencies — how one agent’s decision ripples through to others.

These skills also form the basis of real-world business decision-making and policy assessment — helping students connect academic knowledge to practical action.

Careers Links

This topic supports several Gatsby Benchmarks, especially:

• Benchmark 4 (Linking curriculum learning to careers):

  • Economists, policy analysts, sustainability consultants, environmental officers all use this kind of thinking in their day jobs.

• Benchmark 5 (Encounters with employers and employees):

  • Invite a local sustainability officer or council representative to discuss local environmental policies or traffic regulation decisions.

• Benchmark 6 (Experience of workplaces):

  • A case study project tied to environmental consultancy or planning might give students a mini simulation of how these theories are used in practice.

The skills developed here also align with routes into government policy, urban planning, environmental economics, and ESG investment.

Teaching Notes

Tips for Delivery

• Start local: Begin with an issue that affects your area (e.g. air pollution, recycling, public transport).

• Diagrams first, definitions second: Many students find it easier to grasp welfare concepts when visualising marginal costs and benefits.

• Mini debates: “Should junk food advertising be taxed?” or “Do electric scooters cause more harm than good?” Work well to build evaluation skills.

• Use case studies: Encourage students to write short responses analysing whether a policy internalises externalities.

Common Pitfalls

• Mixing up private and external costs: Use colour-coded diagrams to highlight the difference.

• Forgetting to label axes and curves correctly: Build muscle memory early through regular low-stakes practice.

• Overcomplicating evaluation: Remind students the strongest arguments are clear, not complex.

Extension Ideas

• Introduce behavioural economics: Explore how nudges can help with positive externalities.

• Link with geography or science: Climate change, biodiversity, and urban planning offer rich cross-curricular connections.