1.3
TYPES OF MARKET FAILURE
MARKET FAILURE
when the free market or price mechanism leads to inefficient allocation of
resources
too much or too little is consumed or produced
EXTERNALITIES
the cost or benefit that a third party receives from the production or
consumption of a good or service
this leads to the over or under production of the good
resources are not allocated efficiently
e.g - cars, cigarettes are negative externalities
e.g - healthcare, education are positive externalities
UNDER PROVISION OF PUBLIC GOODS
goods or services are underprovided by the free market
public goods are available and accessible for everyone
e.g - streetlights
INFORMATION GAPS
information gaps arise when one party has more information in a transaction
resources are not allocated to maximise welfare
results in irrational decision making
1.3 1
, EXTERNALITIES
EVAL
difficult to measure the exact externality and quantify and attatch an exact value
created employment opportunities
long term impact
PRIVATE, EXTERNAL, SOCIAL - COSTS AND BENEFITS
PRIVATE - costs/benefits to the individual participating in economic activity
EXTERNAL - costs/benefits to a third party uninvolved
SOCIAL - costs/ benefits to the society as a whole
EXTERNALITIES
Marginal cost / benefit is the additional cost/benefit of consuming/producing
one extra unit
MARGINAL PRIVATE BENEFIT (MPB) - additional satisfaction by the individual
of consuming one more good
MARGINAL SOCIAL BENEFIT (MSB) - additional gain to the society of
consuming one more good
MARGINAL PRIVATE COST (MPC) - additional cost to the individual of
producing one more good
MARGINAL SOCIAL COST (MSC) - additional cost to society of producing one
more good
MSC = MPC+MEC(marginal external cost)
MSB = MPB +MEB
NEGATIVE EXTERNALITY
When consumption or production harms third parties outside of the price
mechanism
1.3 2
TYPES OF MARKET FAILURE
MARKET FAILURE
when the free market or price mechanism leads to inefficient allocation of
resources
too much or too little is consumed or produced
EXTERNALITIES
the cost or benefit that a third party receives from the production or
consumption of a good or service
this leads to the over or under production of the good
resources are not allocated efficiently
e.g - cars, cigarettes are negative externalities
e.g - healthcare, education are positive externalities
UNDER PROVISION OF PUBLIC GOODS
goods or services are underprovided by the free market
public goods are available and accessible for everyone
e.g - streetlights
INFORMATION GAPS
information gaps arise when one party has more information in a transaction
resources are not allocated to maximise welfare
results in irrational decision making
1.3 1
, EXTERNALITIES
EVAL
difficult to measure the exact externality and quantify and attatch an exact value
created employment opportunities
long term impact
PRIVATE, EXTERNAL, SOCIAL - COSTS AND BENEFITS
PRIVATE - costs/benefits to the individual participating in economic activity
EXTERNAL - costs/benefits to a third party uninvolved
SOCIAL - costs/ benefits to the society as a whole
EXTERNALITIES
Marginal cost / benefit is the additional cost/benefit of consuming/producing
one extra unit
MARGINAL PRIVATE BENEFIT (MPB) - additional satisfaction by the individual
of consuming one more good
MARGINAL SOCIAL BENEFIT (MSB) - additional gain to the society of
consuming one more good
MARGINAL PRIVATE COST (MPC) - additional cost to the individual of
producing one more good
MARGINAL SOCIAL COST (MSC) - additional cost to society of producing one
more good
MSC = MPC+MEC(marginal external cost)
MSB = MPB +MEB
NEGATIVE EXTERNALITY
When consumption or production harms third parties outside of the price
mechanism
1.3 2
