CH 7: MARKET INEFFICIENCIES

Externalities

The costs or benefits of a market activity that affect a third party.

Market Failure

Occurs when there is an inefficient allocation of resources in a market.

Internal costs

The costs of a market activity paid only by the participants.

External costs

The costs of a market activity imposed on people not participating in that market.

Social costs

The sum of the internal costs and external costs of a market activity.

Third party problems

Occur when those not directly involved in a market activity experience positive or negative externalities.

Social optimum

The price and quantity combination that maximizes net social welfare for society, taking all external costs and benefits into account.

Internalize

When an individual or firm involved in a market activity takes into account the social costs or benefits of their actions.

Property rights

Give the owner the ability to exercise control over a resource.

Private property

Provides exclusive right of ownership that allows for the use and exchange of property.

Coase theorem

If there are no barriers to negotiations, and if property rights are fully specified, interested parties will bargain to correct externalities.

Excludable good

It is possible to prevent consumers who have not paid for it from having access to it.

Rival good

The good cannot be enjoyed by more than one person at a time.

Private good

Are both excludable and rival in consumption.

Public good

Can be consumed by many; difficult to exclude nonpayers from consumption.

Free rider problem

Someone has the ability to receive the benefit of a good without paying for it.

Club good

Nonrival and excludable.

Common-resource good

Rival and nonexcludable.

Cost-benefit analysis

A process used to determine whether the benefits of providing a public good or undertaking a project outweigh the costs.

Tragedy of the commons

Occurs when a rival (but nonexcludable) good becomes depleted or ruined because individuals overuse it out of self-interest with no one to enforce conservation.

Cap and trade

A system of pollution "permits" traded on an open market that creates property rights for pollution and allows firms to buy or sell emissions allowances.