Section 5 - Market Failure Flashcards
Market Failure
When the price mechanism (i.e. the forces of supply and demand) fails to allocate resources efficiently, causing a social welfare loss.
Externalities
The costs or benefits that producing or consuming a good/service has on an uninvolved third party.
Positive externality
The external benefits to a third party.
Negative externalities
The external costs to a third party.
Why does market failure occur?
Market failure occurs because in a free market the prime mechanism will only take into account the private costs and benefits, but not the external costs and benefits. (Externalities are ignored.)
Private cost
The cost of producing or buying goods and services to either a consumer or a firm. e.g. Cost to firm to make a good.
External Cost
The cost producing or consuming a good or service has on a third party. They are caused by externalities. e.g. cost to council to pay someone to pick up a littered crisp packet.
Social cost
The full cost borne by society of a good or service. Private cost + External Cost.
Private benefit
The benefit of producing or buying goods and services to either a consumer or a firm. e.g Benefit to consumer of buying a ski holiday may be their enjoyment.
External benefit
The benefit producing or consuming a good or service has on a third party. They are caused by externalities. e.g. Factory may invest in new equipment which needs less electricity which benefits the environment as impact on climate is lessened.
Social benefit
The full benefit received by society from a good or service. Private benefit + external benefit.
Marginal private cost (MPC)
Cost of producing the last unit of a good.
Marginal social cost (MSC)
Marginal private cost + the external cost
What is the difference between the MSC and MPC called.
The external cost of production - the negative externalities.
What does it mean if the MSC and MPC curves are parallel or diverged.
If they are parallel then external costs per unit produced are constant. If the curves diverge the external costs per unit increase with output.
E.g may diverge due to pollution - the external costs per unit created by pollution can increase as output increases.
