Market Failure Vocab

Market Failure

When the free market fails to allocate resources efficiently, resulting in a loss of social welfare

Ex. Pollution, under-provision of education

Allocative Efficiency

Occurs when resources are distributed in a way that maximizes total social welfare (where MSC = MSB)

Ex. Optimal output of healthcare

Social Cost (SC)

The total cost to society from producing or consuming a good

SC = PC + EC

Social Benefit

The total benefit to society from a good

SB = PB + EB

Externalities

A cost or benefit felt by third parties not involved in an economic transaction

Negative Externality of Production

External costs created during production

Ex. Factory emissions, water pollution

Negative Externality of Consumption

External costs created during consumption

Ex. Cigarette smoke, drunk driving

Positive Externality of Production

External benefits generated during production

Ex. Renewable energy R&D that benefits society

Positive Externality of Consumption

External benefits from consumption

Ex. Vaccinations, education

Marginal Private Cost (MPC)

Prices paid by the consumer in addition to purchase price

Marginal Private Benefit (MPB)

The benefit of an individual consuming one more unit of a good or service

Marginal Social Cost (MSC)

The extra cost to society of producing one more unit of a good or service

MSC = MPC + EC

Marginal Social Benefit (MSB)

The extra benefit of society of consuming one more unit of a good or service

MSB = MPB + EB

Indirect Tax

A tax imposed on expenditure that increases production costs and reduced supplies, usually a flat rate

Used to correct negative externalities

Ad Valorem Tax

A percentage-based varying tax placed on the sale price of a good or service as opposed to a flat rate

Ex. Varying rate depending on product characteristics and price

Subsidy

A payment from the government to firms to reduce production costs and increase supply

Used to correct positive externalities

Regulation

Rules or laws that restrict or mandate certain behaviors

Ex. Bans on smoking in public places

Tradable Permits (Cap-and-Trade)

A market-based system where the government issues permits for pollution that firms can trade

Goal: reduce external costs efficiently

Price Floor

Minimum legal price; set above equilibrium

Ex. minimum wage

Price Ceiling

Maximum legal price; set below equilibrium

Example: rent controls

Command-and-Control Policies

Regulations requiring specific actions

Ex. mandatory filters on factories

Merit Good

A good that is under consumed in the free market because individuals underestimate its private benefits

Ex. Education, healthcare, museums, vaccinations

Demerit Good

A good that is overconsumed because individuals underestimate its private costs

Ex. Alcohol, cigarettes, junk food

Information Asymmetry

A situation in which one party has more or better information than another

Ex. Drug side effects, used car quality

Bounded Rationality

Consumers may make decisions that are not in their best interest due to lack of information, bias, or cognitive limits

Public Good

Non-rivalrous and non-excludable

Ex. street/road lighting, national defense

Issue: Free rider problem

Private Good

Rivalrous and excludable; provided efficiently by markets

Common Access Resources (CARs)

Non-excludeable but rivalrous resources

Ex. Fisheries, forests, oceans

Issues: Overuse, tragedy of the commons

Tragedy of the Commons

Where individuals, acting in their own short-term self-interest, deplete a shared resource that is not privately owned, which ultimately harms everyone in the long run

Sustainability

Meeting current needs without compromising the ability of future generations to meet theirs

Monopoly Power

The ability of a firm to influence price due to a lack of competition

Ex. Only broadband provider in a region

Cartel

A group of firms colluding to set prices or output

Ex. OPEC's oil production agreements

Equity

Fairness in the distribution of income and wealth

Ex. Progressive taxation rates

Efficiency

Maximizing output/welfare without wasting resources

Ex. The circular economy model