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.

  </p>

  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.

  </p>

  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

  </p>

• 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

  </p>

• 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).

  </p>

• 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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