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What is a market failure?
A situation in which individual decisions do not lead to socially desirable outcomes.
What can cause market failures?
Externalities, public goods, and imperfect information.
What are externalities?
Effects of a decision on a third party that are not considered by the decision-maker.
What are negative externalities?
Detrimental effects on others resulting from a decision, such as second-hand smoke.
What is an example of a positive externality?
Education, as it provides benefits to society beyond the individual receiving it.
How is marginal social cost calculated in the presence of negative externalities?
It includes the marginal private costs plus the costs of negative externalities associated with production.
What is the equilibrium in a market with no externalities?
The private and social benefits are equal, maximizing society's welfare.
What happens to the equilibrium when there are negative externalities?
The competitive price will be too low to maximize social welfare.
What is an optimal policy?
A policy where the marginal cost equals the marginal benefit, avoiding waste of resources.
What characterizes a public good?
It is nonexclusive and nonrival, meaning no one can be excluded from its benefits and consumption by one does not preclude consumption by others.
What is the free rider problem?
Individuals’ unwillingness to share the cost of a public good, often discouraging social contributions.
What are the assumptions of perfect competition?
Many sellers and buyers, identical goods, and no barriers to entry.
What is allocative efficiency?
An outcome where marginal benefit equals marginal cost (MB=MC).
What market structures deviate from perfect competition?
Oligopolies, monopolistic competition, and monopoly.
What is the implication of firms having market power?
They are price makers, leading to deviations from allocative efficiency.
What is an example of a public good?
National defense is the closest example of a public good.
Market failure
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