Ch 9 - Market Failure 

  • Market failure occurs when resources aren’t allocated in an optimal manner, meaning

  that the market isn’t allocatively efficient, and community surplus isn’t maximized.

  1. Signs of market failure:

   
   1. Shortage
   2. Surplus
   3. High prices
   4. Bad quality

  • Types of goods:

  
  1. Demerit goods are goods or services considered to be harmful to people who consume

  them and to society as a whole, that would be over-provided by the free market and so

  over-consumed.

  2. Merit goods are goods or services considered to be beneficial for people who use them

  and society as a whole, that would be under-provided by the free market and so under-

  consumed.
  * Tradable permits is a market-based solution to negative externalities of production. They

    are permits to pollute, issued by government, which sets a maximum amount of pollution

    allowable. Firms may trade these permits for money.

  3. Public goods are goods or services which would be under-provided or not provided at all

  by the free market. They are non-excludable and non-rivalrous, making it pointless for

  private individuals to provide the good themselves.
  * Sustainability/Sustainable development is where consumption needs of the present

  generation are met without reducing the ability to meet the needs of future generations

  • Private cost: cost on you, as a consumer

  • Private benefit: benefit for you, as a consumer

  • External cost: cost on other people because of you

  • External benefit: other people’s benefit because of you

  • Social cost: private and external cost

  • Social benefit: private and external benefit

  • Marginal social cost (MSC): total cost society pays for the production of another unit of taking further action in the economy
      * Total cost is calculated as:
        * MPC = marginal private cost
        * MEC = marginal external cost (+ive,-ive)

  • Marginal social benefit (MSB): individuals social benefit, plus overall benefit to society from one additional unit of production
      * Includes positive and negative externalities that impact individual societies
      * MSB = MPB + external benefit

  • Externalities: when a production or consumption of a good has an effect on third party occurrence
      * Actions that have a -ive or +ive effect on others

  • Negative Externalities: are the ‘bad’ effects that are suffered by the third party, for which

  the third party doesn’t get compensated, when a good or service is produced or

  consumed

  
  1. Negative externalities of production and consumption
  2. MSC>MPC
  3. MSC = MPC + MEC
     * negative externalities of consumption: occur when the consumption of a good or service creates the external costs that is damaging to third parties (MSB

  • Positive Externalities: are the beneficial effects that are enjoyed by a third party, but not paid for by the third party, when a good or service is produced or consumed

  
  1. positive externalities of production and consumption
  2. MSB > MPB
     * Positive externalities of production: occur when the production of a good or service creates external benefits for third parties (MPC>MSC).
     * Positive externalities of consumption: occur when the consumption of a good or service creates external benefits for third parties (MSB>MPB).

  • Externalities inefficiency:

  
  1. Market may not maximise total surplus
  2. When externalities in the free market result in less efficiency private benefits/costs which are not equal to social benefit/costs