2.8a Market Failure - Negative Externalities + CPRs Flashcards Preview

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Flashcards in 2.8a Market Failure - Negative Externalities + CPRs Deck (18)
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1
Q

When does market failure occur?

A

Market failure occurs when resources are not allocated efficiently, the market does not maximise the welfare of society.

(It means that the marginal social costs resulting from the production and consumption of the good do not equal the marginal social benefits. )

2
Q

What are the 3 Marginal costs?

A

MPC - Marginal Private Cost
- The additional private costs incurred by individuals from the production or consumption of an extra unit of a good
MEC - Marginal External Costs
- The additional social costs incurred by third parties not involved in the production or consumption of an extra unit of output.
MSC - Marginal Social Cost
- It is the sum of the marginal private costs and the marginal external costs

3
Q

What is the marginal social cost (equation)?

A

MSC = MPC + MEC

4
Q

What are the 3 Marginal benefits?

A

MPB - Marginal Private Benefits
- The marginal added value (Marginal private benefits) enjoyed by individuals and firms from the consumption or production of 1 extra unit of output
MSB - Marginal Social Benefits
- Total benefits enjoyed by society from the consumption or production of 1 extra unit of output
MEB - Marginal External Benefits
- Additional benefit incurred by third parties not involved in the consumption of production of 1 extra unit of output

5
Q

What is the marginal social benefit (equation)?

A

MSB = MPB + MEB

6
Q

How do you find welfare loss on an externalities diagram?

A

If its a Negative externality the welfare loss is <
If its a Positive externality the welfare loss is >
( Point of triangle is ALWAYS where MSC = MPB)

7
Q

What are Negative externalities?

A

A negative externality is a cost that is suffered by a third party as a consequence of an economic transaction

8
Q

What are demerit goods?

(negative externalities of CONSUMPTION)

A

Demerit Goods are goods which create negative spillover effects (negative externalities)
to third parties not involved in the production or consumption of the good
These goods are harmful to consumers, but people who consume these goods are either unaware of the harmful effects or they ignore them. Therefore the demand for demerit goods is higher then it should be from society’s point of view.

(eg. alcohol, cigarettes..)

9
Q

Explain the DIG using the example of cigarettes (demerit good):

A

–> The negative externalities of consumption created by smoking (such as positive smoking and drain on the healthcare system) mean that the Marginal social benefits are less than the marginal private benefits. In a free market consumers consume cigarettes at the level where MSC = MPB. They ignore the negative externalities they create. This means that there is overconsumption of of cigarettes at P x Q. The social level optimum level of cigarettes is Q opt and P opt. Since MSC is greater than MSB, this is the welfare loss (as shown by area ABC) and market failure.

10
Q

What are usually examples of negative externalities of PRODUCTION?

A

Negative production externalities mainly relate to (but not exclusively) environmental damage, where economic activity creates a threat to sustainability.

11
Q

Why do private firms create negative externalities?

A

Private firms are profit-maximisers and are only interested in their private costs, not external costs. Therefore they will ignore the overall cost of their activity to society now and in the future.
–> Marginal social cost greater than marginal private cost

12
Q

Explain the DIG using the example of a chemical producing private firm:

A

–> The marginal private costs of the firm are lower than the marginal social costs, because there are external costs associated with the production of chemicals (such as pollution of the river of loss of jobs for fishermen due to the dying fish). Because the firm is only interested in the private costs, they produce at output Q at a price P. Whereas society would want the production of chemicals at quantity Q opt and price P opt. There is a misallocation of resources and overproduction of chemicals which leads to market failures. There is a welfare loss triangle because the marginal social costs of producing chemicals are higher than the social benefits.

13
Q

What are common pool resources?

A

CPR are typically natural resources, such as fishing grounds, forests, and pastures, or human-made systems for managing natural resources, such as irrigation systems

14
Q

What are some problems with common pool resources?

A
  • One problem with such resources is that it is very difficult or very expensive to exclude people from using them
  • CPRs are non excludable as it is not possible to prevent those who are unwilling or unable to pay from benefitting once the resource is provided. These are called ‘free-riders’
  • As CPRs are freely available, there tends to be overproduction and overconsumption of these goods
  • CPRs are difficult to sustain and without government intervention it will lead to their depletion or destruction
15
Q

How does market failure take place (Common pool resources)?

A

The benefits to the individual outweigh the external cost and give the individual the incentive to keep using the resource
–> So market failure will take place because of over-consumption

16
Q

CPRs are non-excludable and r______, what does this mean?

A

Non-excludable and RIVALROUS

Non excludable:
it is not possible to prevent those who are unwilling or unable to pay from benefitting once the resource is provided.

Rivalrous:
If one person uses the good, it reduces the availability of the good for others

17
Q

CPRs create the “Tragedy of the commons”, what is this?

A

If producers realize the damage they cause to the environment 1 producer may decide to decrease the use of the CPR

  • -> Ineffective as other producers will continue to use the CPRs
  • -> Depletion of resources
18
Q

What is a possible solution to the “Tragedy of the commons”?

A

A solution would be to have a common agreement on how to use these resources

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