2.8 Market failure - externalities and common pool or common access resources

IB Economics

Market failure

occurs due to an inefficient allocation of resources

Marginal private benefit (MPB)

Additional benefits to consumers from an extra unit output.

Marginal social benefit (MSB)

Additional benefits to society from an extra unit of output.

Marginal private cost (MPC)

Additional costs paid by producers from an extra unit of output

Marginal social cost (MSC)

Additional costs paid by society from an extra unit of output.

Marginal external benefit (MEB)

Additional benefits to third parties from an extra unit of output.

Marginal external cost (MEC)

Additional costs to third parties from an extra unit of output.

Positive externalities of consumption

Positive spill-over effects generated to third parties as a result of consuming merit goods.

Merit goods

Goods associated with positive externalities of consumption.

MSB > MPB

Positive externalities of production

Positive spill-over effects generated to third parties as a result of production activities.

negative externalities of consumption

Spill-over costs generated to third parties by consumers

during consumption activities.

Demerit goods

Goods associated with negative externalities of consumption. Where MSC> MPC

negative externalities of production

Spill-over costs generated to third parties by producers

during production activities.

Carbon tax

Imposed on producers for carbon emissions from production activities with the aim of minimizing environmental pollution.

Tradable permits (Cap and trade scheme)

Limits the level of pollutants to a level pre-determined by the government.

Collective self-governance

The voluntary communal actions that combat negative externalities.

Common access resources

Rivalrous and non-excludable resources. (E.g. Clean air, fish stocks and trees)

(Non) Rivalrous

Consumption of a resource reduces the amount available for others to use (CAR are scarce)

(Non) Excludable

It is impossible to prevent non-payers from benefitting from the resource (CAR are over-used)

Tragedy of the commons

Where degradation, depletion or destruction of a common access resource is caused by rivalry and over-consumption.