Unit 6: Market Failure and Government Interventions

Market Failure

Occurs when the free market fails to allocate resources efficiently, leading to a quantity produced that does not maximize total social surplus.

Marginal Private Cost (MPC)

The cost for the producer to produce one additional unit, represented by the Supply curve.

Marginal External Cost (MEC)

The uncompensated cost imposed on third parties, such as pollution.

Marginal Social Cost (MSC)

The total cost to society, calculated as MSC = MPC + MEC.

Marginal Private Benefit (MPB)

The benefit the consumer receives from consuming one additional unit, represented by the Demand curve.

Marginal External Benefit (MEB)

The uncompensated benefit that spills over to third parties, such as herd immunity.

Marginal Social Benefit (MSB)

The total benefit to society, calculated as MSB = MPB + MEB.

Allocative Efficiency

Achieved when MSB = MSC, indicating a socially optimal market.

Deadweight Loss (DWL)

The loss of economic efficiency that occurs when equilibrium is not achieved at the socially optimal quantity.

Externality

A cost or benefit that affects a third party who did not choose to incur that cost or benefit.

Negative Externality

Occurs when a firm or consumer incurs costs onto society, such as pollution from a factory.

Positive Externality

Occurs when consumption or production creates benefits for others, like vaccinations or education.

Per-Unit Tax

A government tax imposed to correct negative externalities, equal to the marginal external cost (MEC).

Per-Unit Subsidy

A government payment provided to correct positive externalities, equal to the marginal external benefit (MEB).

Common Resources

Resources that are rival in consumption but non-excludable, often suffering from the Tragedy of the Commons.

Public Goods

Goods that are non-rival and non-excludable, leading to the Free-Rider Problem.

Free-Rider Problem

A situation where individuals consume a good without paying for it because the good is non-excludable.

Tragedy of the Commons

A situation where individuals deplete a shared resource due to competing self-interest.

Rivalry in Consumption

A characteristic where one person's consumption reduces the amount available for others.

Excludability

The ability of the supplier to prevent non-payers from consuming the good.

Private Goods

Goods that are both rival and excludable, such as ice cream or shoes.

Club Goods

Non-rival but excludable goods, such as Netflix or cable TV.

Fixed Costs

Costs that do not change with the level of output, unaffected by lump-sum taxes or subsidies.

Coase Theorem

The principle that private parties can negotiate solutions to externalities if transaction costs are low and property rights are clear.

Graph Analysis

The visual representation of economic concepts to analyze the relationships between supply, demand, costs, and benefits.

Government Intervention

Actions taken by the government to correct market failures and achieve a socially optimal outcome.

Market Equilibrium

The point at which the supply and demand curves intersect, indicating the quantity of goods produced and consumed at market prices.