Market Failures

Positive Externalities

Spill over of benefits to third parties that weren’t included in the transaction.

Reason for Failure

Quantity is less in a free market than the socially optimal point.

Free market only considers

private costs and benefits

Negative Externalities

External costs on others that cause the MSC to be greater than the MPC.

Free Rider

A person who uses a collective good without paying for it.

Nonexcludable

Everyone can use the good, even those that don’t pay.

Nonrival

One person’s consumption of a good does not reduce the usefulness to others.

Excludable

Must pay to use.

Rival

Only one person can use it at a time.

Common goods

Nonexcludable, rival

Private goods

Excludable, rival

Public goods

Nonrival, nonexcludable

Coase Theorem

If those who are affected by an externality can negotiate, they may arrive at an efficient solution to the externality problem.

Lorenz Curve

A graph of income inequality that shows what percentage of a country’s income is being earned by a percentage of the country’s households.

The closer the Lorenz curve is to the line of equality…

the more evenly distributed the income

Gini Coefficient

The area between the line of equality and the Lorenz Curve

Unequal

1

Equal

0

The Invisible Hand

Individual self interest leads to economic efficiency.

Market Failures

Externalities, free rider problem, tragedy of the commons, and income inequality.

solution to tragedy of the commons

property rights

Theorem that assumes there are no transaction costs.

Coase

Tragedy of the Commons

Individuals with access to a public resource have no regard to others and deplete the resource.