Market Failures: Public Goods and Externalities

Set of flashcards covering key vocabulary and concepts related to market failures, public goods, externalities, and government intervention in economics.

Market Failures

Occurs when the market fails to produce the right amount of a product, leading to overallocation or underallocation of resources.

Demand-Side Failures

Happen when it is impossible to charge consumers what they are willing to pay for a product, allowing some to benefit without paying.

Supply-Side Failures

Occur when a firm does not pay the full cost of producing its output, resulting in external costs not reflected in supply.

Efficiently Functioning Markets

Markets are efficient when the demand and supply curves reflect the full willingness to pay and costs of production.

Productive Efficiency

Production at the lowest cost.

Allocative Efficiency

Production that is most valued by society, where resources are allocated efficiently.

Consumer Surplus

The difference between the maximum price a consumer is willing to pay and the actual price paid.

Producer Surplus

The difference between the actual price a producer receives and the minimum acceptable price.

Allocative Efficiency Conditions

1. MB = MC; 2. Maximum willingness to pay = Minimum acceptable price; 3. Combined consumer and producer surplus is maximized.

Public Goods Characteristics

Goods provided by the government that are nonrivalrous and nonexcludable, creating a free-rider problem.

Cost-Benefit Analysis

A method to evaluate the cost of diverting resources from private goods to producing public goods versus the satisfaction gained.

Externalities

Costs or benefits that accrue to a third party external to the transaction.

Positive Externalities

Occurs when too little of a good is produced, typically due to demand-side market failures.

Negative Externalities

Occurs when too much of a good is produced, typically due to supply-side market failures.

Government Intervention

Actions taken to correct market failures caused by externalities, including taxes and subsidies on goods.

Tax Burden Principles

Based on the costs taxes impose on society, including benefits-received and ability-to-pay principles.

Types of Taxes

Progressive tax (tax increases with income), regressive tax (tax decreases with income), and proportional tax (tax remains the same regardless of income).

Tax Progressivity

The relationship between income levels and tax rates, with progressive taxes imposing a higher rate on higher incomes.

Federal Tax System

The federal income tax system is progressive, while state and local tax structures tend to be regressive.

Government's Role in the Economy

The government plays a role in correcting externalities and must identify their existence and causes.