Market Failures: Externalities, Public Goods

Market Equilibrium

State where supply equals demand, leading to efficient allocation of goods.

Private Coffee Supply Curve

Graphical representation showing the quantity of coffee producers are willing to supply at different prices.

Private Coffee Demand Curve

Graphical representation showing the quantity of coffee consumers are willing to buy at different prices.

Consumer Surplus

Difference between what consumers are willing to pay and the market price.

Producer Surplus

Difference between market price and the marginal cost of production.

Total Surplus

Sum of consumer surplus and producer surplus in a market.

Efficient Market Allocation

Achieved when social marginal cost equals social marginal benefit.

Negative Externality

Occurs when an action imposes costs on others without compensation.

Positive Externality

Occurs when an action benefits others without compensation.

Market Failure

Occurs when the allocation of goods and services is not efficient.

Production Externalities

Arise during the production of goods or services, affecting third parties.

Consumption Externalities

Arise when consumption of a good affects third parties.

Missing Prices

Absence of prices for goods like clean air or biodiversity, leading to market inefficiencies.

Social Value of Goods

Value of goods to society, often signaled by market prices.

Consumption externalities

Generated during consumption (e.g., congestion, vaccination)

Negative externalities

Imposes external costs (e.g., pollution)

Positive externalities

Imposes external benefits (e.g., vaccination)

DDT

Chemical insecticide causing cancer/reproductive issues

Diclofenac

Painkiller toxic to vultures, increasing human mortality

Social marginal cost (SMC)

Sum of private and external marginal costs

Private marginal cost (PMC)

Costs of production excluding externalities

External marginal cost (EMC)

Costs external to the producer

Deadweight loss (DWL)

Loss to society due to unregulated externalities

Key takeaway

Private market overproduces, causing negative externalities

PMB

Private marginal benefit not accounting for external costs.

SMB

Social marginal benefit including external benefits.

PMC

Private marginal cost of production.

EMC

External marginal cost added to private production cost.

Q∗

Optimal quantity where social benefit equals social cost.

QU

Unregulated quantity causing market inefficiency.

DWL

Deadweight loss from market inefficiency.

Positive Externalities

Benefits external to the transaction, e.g., vaccines.

Negative Externalities

Costs external to the transaction, e.g., pollution.

Free-Rider Problem

Market failure where beneficiaries avoid paying full costs.

Public Goods

Non-rival, non-excludable goods like clean air.

Herd Immunity

Indirect protection from infectious diseases.

Private Actors

Entities not considering external impacts.

Social Welfare

Overall well-being of society.

Total DWL

Sum of deadweight losses in a market.

Market Efficiency

Optimal allocation of resources.

External Benefits

Positive effects beyond direct participants.

External Costs

Negative impacts affecting non-participants.

Private Costs

Expenses borne by individual entities.

Social Costs

Total expenses including external impacts.

Market Outcome

Result of interactions between buyers and sellers.

MB

Marginal benefit from tending the garden

MBA

Anna's marginal benefit from tending the garden

MBB

Beth's marginal benefit from tending the garden

MBC

Charles's marginal benefit from tending the garden

MC

Marginal cost of tending the garden

QA

Quantity of garden appearance Anna tends to

QB

Quantity of garden appearance Beth tends to

QC

Quantity of garden appearance Charles tends to

Lindahl Pricing

Charging each group based on their marginal benefit from the socially optimal quantity