2.4 - market failure, MPB, MSB, MPC, MSC, externalities,

market failure

occurs when the allocation of resources, goods and services is less than optimal

causes of market failures

• public goods

• common pool resources

• negative externalities of consumption

• negative externalities of production

• positive externalities of consumption

• positive externalities of production

marginal private benefit MPB

the additional benefit received by consumers from consuming one more unit of a good or service.

marginal private cost MPC

the additional cost incurred by producers for producing one more unit of a good or service.

marginal social benefit MSB

the total benefit to society from the consumption of one more unit of a good or service.

marginal social cost MSC

the total cost to society of producing one more unit of a good or service.

socially optimum output

MSB = MSC

• level of output desired without market failure

negative externalities of production

• created during production

• failing due to over-provision

• producers only consider private and not external costs

  • air pollution, water contamination, health problem

ways of correcting negative externality of production

• taxation

• regulation and legislation

• subsidies

• tradable permits

negative externalities of consumption

• caused during consumption of demerit goods

• failing due to over-consumption

• consumers consider only private costs and not external

  • waste

ways of correcting negative externalities of consumption

• education

• taxation

• regulation

• campaigns and advertisements to improve consumer behavior

demerit goods

Goods that are considered harmful to individuals and society

merit goods

Goods that are deemed beneficial for individuals and society, often under-consumed if left to the market.

positive externalities of production

• created during production

• market is failing due to under-provision

• only private benefits are considered by producers and not external

ways of correcting positive externalities of production

• subsidies

• regulations

• direct government provision of goods that enhance social benefits.

• price floor

positive externalities of consumption

• created during consumption of merit goods

• failing due to under-consumption

• customers only consider private benefit and not external

ways of correcting positive externalities of consumption

• subsidies to consumers

• public awareness campaigns

• government provision of merit goods

• consumer nudges