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.

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  1. Signs of market failure:

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

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  • 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.

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    1. 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.

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    1. 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

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  • Private cost: cost on you, as a consumer

  • Private benefit: benefit for you, as a consumer

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

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  • Social cost: private and external cost
  • Social benefit: private and external benefit

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  • 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

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  • 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<MPB)
    • Negative externalities of production: occur when the production of a good or service creates external costs that are damaging to third parties (MSC>MPC).

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  • 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).

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  • 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

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