Market Failure

Allocative efficiency

• Maximisation of society surplus (D = S)

• Maximisation of net social benefit (MSB = MSC)

• Where resources perfectly follow consumer demand (D = S)

Assymptions for allocative efficiency

• Many buyers/sellers

• Perfect information

• No barriers to entry

• Firms are profit maximisers

• Consumers are utility maximisers

Market Failure

When the free marker fails to allocate resources of the socially optimum level of output.

Negative Externalities

Costs to 3rd parties as a result of the actions of a separate agent.

NE in production

MSC > MPC (there are external costs)

• Air pollution

• Deforestation

Effects of NE in production

• Over production

• Price too low

NE in consumption

MSB < MPB (There are negative external benefits)

• Smoking

• Air pollution

Effect of NE in consumption

Overconsumption

Positive Externalities

Benefits to 3rd parties as a result of the actions of agents.

PE in consumption

MSB > MPB (Positive benefits)

• Healthcare

• Education

Effect of PE in consumption

Underconsumption

PE in Production

MSC < MPC (Negative costs)

• Technology

Effect of PE in production

Underproduction

Merit goods

Goods more beneficial to consumers than they realize.

Demerit goods

Goods more harmful to consumers than they realize.

Non excludable goods

No price can be charged (anyone can access and no cost efficient way to price)

Non-rival

Quantity of good doesn’t diminish upon consumption.

Tragedy of Commons

Since common access resources have no private ownership, producers will exploit these goods, leading to resource-depletion.

Free-Rider Problem

When people are benefitting from resources, goods or services that they do not pay for.