Negative externalities & positive externalities

• LO

• •Define market failure

• •Explain the market failure in relation to negative and positive externalities

• •Identify and describe policies to address the market failure associated with externalities

• •Use diagrams to illustrate the effect of policies to address the market failure associated with externalities

Market failure

• situation where market fails to operate efficiently, result in misallocations of resources

  • resources not allocated in most efficient way to benefit society

• Examples

  • positive externalities

  • negative externalities

  • lack of public goods

Externalities

• benefits/cost to third party → economic transaction

  • 3rd party: people/groups not participants in transaction

  • not involved in buying, consuming, producing in buying, consuming, producing or selling product

• markets will fail to take these externalities into account unless there is gov intervention

Negative externalities

• 3rd party affected negatively (external costs))

  • in production

  • in consumption

• Example of products with negative externality

• free market not account for external costs

  • over-allocation of resources towards products with negative externalities

• gov intervenes to discourage consumption &/or production

  • excise tax/fines → more expensive

  • subsidies → for products without negative externalities

  • mandates → laws disallowing/ limit productions &/or consumption

  • behavioral nudges → thru psychology & behavioral economics theories to influence decision making

• discourage product w negative externality

• demand decrease → law banning smoking in public areas

• fewer resources allocated towards this product

• equilibrium quantity decrease, price decrease