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

Introduction

This article focuses on Topic 1.3.2 from the Pearson Edexcel A Level Economics A specification: Externalities. Part of the broader theme of market failure, this unit challenges students to explore what happens when the free market doesn’t deliver the most beneficial outcomes for society. The concept of externalities sits at the heart of many real-life economic debates, from climate change to education funding, and provides rich ground for engaging, contextualised teaching.

Theme 1 is foundational for Paper 1 and connects directly with Theme 3 later in the course. By tackling this topic, students deepen their ability to think critically about the allocation of resources and the role of government in addressing market imperfections.

Key Concepts

Students should be able to:

• Distinguish between private costs, external costs, and social costs.

• Distinguish between private benefits, external benefits, and social benefits.

• Use marginal analysis diagrams to:

  • Show the external costs of production and the divergence between private and social costs.

  • Identify the market equilibrium vs the socially optimal position.

  • Highlight the area of welfare loss (in the case of negative externalities).

• Illustrate the external benefits of consumption, again using marginal analysis.

  • Contrast private vs social benefits.

  • Identify welfare gain where underconsumption occurs.

• Evaluate the impact of externalities on economic agents—consumers, producers, and the government.

• Assess how government intervention can address externalities: taxes, subsidies, regulation, and public provision.

Real-World Relevance

Externalities affect nearly every aspect of economic life. Teaching this topic comes alive with relevant, contemporary examples:

Negative externalities:

• Air pollution from car use: The private cost to drivers doesn’t include the wider health and environmental damage.

• Fast fashion: Low-cost clothing may not reflect environmental harm from production waste or social costs like underpaid labour.

Positive externalities:

• Vaccination programmes: Individual choices to vaccinate benefit wider society by contributing to herd immunity.

• Education: Individuals gain skills and income, but the wider economy benefits too—through productivity, lower crime rates, and civic engagement.

Mini case studies or short news pieces can be used to start classroom debate. For instance, the congestion charge in London is a direct attempt to internalise the external costs of car use—ideal for exploring the pros and cons of government intervention.

How It’s Assessed

Externalities are typically assessed through:

• Short-answer explain questions, testing understanding of definitions and diagrams.

• Data response questions, where students apply marginal analysis to real-world scenarios.

• Evaluate questions, asking for judgement on the effectiveness of government interventions.

Command words to look out for:

• Explain: Often requires a definition plus context or an example.

• Analyse: Requires a logical chain of reasoning—especially when interpreting diagrams.

• Evaluate: Involves weighing up benefits and drawbacks, concluding with a reasoned judgement.

Graphical accuracy matters. Students must label diagrams clearly and link them directly to their written analysis to access higher marks.

Enterprise Skills Integration

Externalities are fertile ground for developing enterprise thinking. Key skills embedded in this unit include:

• Decision-making: Assessing how government and firms respond to imperfect market outcomes.

• Problem-solving: Identifying policy tools to address externalities and weighing up trade-offs.

• Critical thinking: Questioning whether market-based solutions always lead to the best societal outcomes.

Encourage students to design a basic policy intervention for a known externality—such as a tax on disposable vapes or a subsidy for solar panels. It builds both understanding and confidence in real-world application.

Careers Links

This topic directly supports Gatsby Benchmarks 4, 5 and 6:

• Gatsby 4: By linking curriculum learning to how policy is designed and evaluated.

• Gatsby 5 & 6: Through case studies that connect to public policy, environmental strategy, and urban planning.

Relevant career pathways include:

• Environmental economist

• Public policy advisor

• Urban planner

• Health economist

• Corporate sustainability officer

Using role-based scenarios—like acting as a local council advisor on air pollution—can make these links tangible and memorable.

Teaching Notes

Tips for delivery:

• Start with relatable examples: noisy neighbours, second-hand smoke, school litter.

• Use simple diagrams early, then introduce marginal social cost/benefit later.

• Embed retrieval practice with regular low-stakes quizzes on definitions and diagrams.

Common pitfalls:

• Students often mix up social and external costs—emphasise that social cost = private cost + external cost.

• Diagrams are often mislabelled—practise drawing them step-by-step in lessons.

• Some students focus only on government action—encourage broader thinking about firm or consumer behaviour changes too.

Extension ideas:

• Debate: “Should fast food companies be taxed for health impacts?”

• Independent research: Investigate a local policy trying to correct a market failure.