Market Failure Flashcards
Market failure
When the free market mechanism fails to allocate resources efficiently (inefficient resource allocation)
Examples of market failure
- Overconsumption
- Underconsumtpion
- Underproduction
- Overproduction
Types/Causes of market failure
1) Externalities
2) Under-provision public goods
3) Information gaps
Externalities
Costs and Benefits that do not go through the price mechanism
Private costs
Any costs a firm pays in order to buy or produce goods and services i.e. cost of labour, material, machinery
External costs/Negative externalities
Costs to a third party arising from production and consumption of goods/services for which no appropriate compensation is paid
Social costs
Total cost of producing product/service to society
- Private costs + External costs
Private benefits
Benefits received by the consumer or the producer
External benefits/Positive externalities
Benefits to third parties which are not taken into account by the price mechanism
Social benefits
Total benefit of producing product/service to society
- Private benefits + External benefits
External costs/Negative externalities of production using marginal analysis
Where the marginal social cost of production is higher than the marginal private cost i.e. MSC > MPC
e.g. air, land, river and noise pollution resulting from factory emissions
Negative externalities private and social optimum
Private (assuming no negative externalities from consumption):
MPC = MPB
Social:
(MPC+Social costs):
MSC = MPB
Welfare loss
Where a firm’s decision to produce decreases the well-being of others, but the firm does not compensate those others
- Qsop up to Qp triangle
External benefits/Positive externalities of consumption using marginal analysis
Where the marginal social benefit of consumption is higher than the marginal private benefit
MSB > MPB
Positive externalities private and social optimum
Private:
(MPC = MSC) = MPB
Social:
(MPC = MSC) = MSB
