Market failure and externalities

What are private costs?

Costs directly incurred by producers or consumers, such as rent, wages, and raw materials.

How are social costs calculated?

Social costs = Private costs + External costs.

What are private benefits?

Benefits directly received by consumers or firms, such as revenue from sales or personal satisfaction.

How are social benefits calculated?

Social benefits = Private benefits + External benefits.

What is the social optimum position?

The point where marginal social costs (MSC) equal marginal social benefits (MSB), maximizing welfare.

What is market failure?

When the free market fails to allocate resources efficiently, leading to a loss of social welfare.

What causes market failure?

Externalities, under-provision of public goods, and information gaps.

What is an externality?

A cost or benefit experienced by a third party outside the market transaction.

Why are public goods underprovided in a free market?

Due to the free-rider problem, where people benefit without paying, leading to a lack of profit incentive for producers.

What are the characteristics of public goods?

They are non-excludable (cannot prevent access) and non-rival (consumption by one doesn't reduce availability to others).

What is the free-rider problem?

When individuals benefit from a good without contributing to its cost, leading to under-provision.

How does imperfect information cause market failure?

Consumers and producers make inefficient decisions due to a lack of accurate information, leading to resource misallocation.