market failure-1.3 micro economics

What is market failure ?

When the price mechanism causes an inefficient allocation of resources leading to net welfare loss

What are externailities

these are either costs of benefits that affect third parties that are not included in the original transaction

What is an external costs ?

theses are negative consequences that affect third parties that are not part of the original transaction

what are private costs ?

costs internal to the market transaction which are therefore taken into account by the price mechanism

what the social costs ?

The sum of external cots and private costs from a market transaction

draw and external costs of production diagram ?

triangle = welfare loss

the gap between marginal social cost and marginal private cost is the external cost

the free market ignores the negative externalities mpc

however when the externalities are taken into account the curve deviates msc

what is a private benefit ?

benefits internal to a transaction. which are therefore taken into account by the price mechanism

i.e. the revenue firms obtain from selling a good or service ?

what are social benefits

by adding private benefit to external benefit = social benefit

why do the marginal private benefit curve and the marginal social benefit curve often diverge

this is because it indicates that external benefits increases disproportionately with output consumed

note :

diagrams of only

the external costs of production

external benefits of consumption

however u can use the external costs of consumption and external benefits of production in explanation

What is the supply curve for firm

this shows the cost on firms for producing a certain goods.

MPC curves of firms in a market for a particular good or service will form the market supply curve

what is market equilibrium ?

occurs at the price and output position where marginal private benefits equals marginal private cost

What is the demand curve for consumers ?

this is the marginal private benefit

economist assume that it is possible to measure benefit obtained from consuming a good by the price people are willing to pay for it

why do demand curves slope downwards i.e. demand curve for consumers - marginal private benefit ?

as an individual consumes more units of are marginal benefit utility will fall.

this is why the demand curve slopes downwards

what is the social optimum equilibrium?

this where the marginal social benefit equals marginal private benefit

the social cost of producing the last unit lf that good equal

s the social benefit of consuming it

when negative external costs aren’t realised how does it lead to market failure

it leads to market failure because there is an under pricing and overproduction of goods that cause harm i.e. tobacco

this results in excess social cost of social benefit

how does not realising external benefit in consumption lead to market failure

this causes market failure because their is an under pricing and underproduction of the good or service.

describe how the external cost diagram is produced

the free market does not take into account the negative externalities

however when the negative externalities are added it causes the supply curve of the firm to shift in and become marginal social costs