2.8-2.9 Market failure (externalities and public goods)

Market failure

The failure of the market to efficiently allocate the resources within an economy. Total social surplus is not maximised, creating welfare loss.

Externalities

A transaction where someone other than the buyer or the seller experiences a benefit or loss as a result of a transaction

Negative externalities of consumption

Use of a product creates external costs to society/third party

Pigouvian tax

A tax on a market transaction that creates a negative externality

Positive externalities of consumption

Use of a product creates external benefits to society/third party

Negative externalities of production

Production of a product creates external costs to society/third party

Common pool resources

Resources that are rivalrous and non-exclude. Not owned by anyone, do not have a price and are available for anyone to use without payment

Cap and trade

When a governing body issues permits to pollute, that sets a maximum amount of pollution allowable. These permits may be traded (bought or sold) in a market for such permits

Positive externalities of production

Production of a product creates external benefits to society/third party

Public goods

Resources that are non-rivalrous and non-exclude. Socially desirable goods not produced by private firms because it is not possible to charge a price

Free rider problem

When people can benefit from consuming resources, goods, or services without having to pay.

Negative externalities of consumption diagram

Positive externalities of consumption diagram

Negative externalities of production diagram

Cap and trade diagram (short term)

Cap and trade diagram (long term)

Incentivise firms to invest in green energy/tech External cost of environmental impact less

Internalising externality

Taxing those who previously cause negative external costs so they pay/take responsibility

Disadvantage of cap and trade

1. Measurement/technical issues regarding production

2. If caps too low: high prices for consumers

3. If caps too high: will not have desired effect

4. Inequity: rich firms may just buy more permits

5. Firms may lay off workers to cut costs

Positive externalities of production diagram

Strategies for correcting neg. ext. of consumption

1. Government regulation and advertisement

2. Pigouvian tax

3. Subsidy for substitutes

Strategies for correcting pos. ext. of consumption

1. Direct provision/subsidy

2. Government regulation and advertising

Strategies for correcting neg. ext. of production

1. Tax on pollutants/product

2. Cap and trade

Strategies for correcting pos. ext. of production

Direct provision/subsidy