1.3 Market Failure Flashcards
Market failure
Market failure occurs when the free market fails to allocate resources to the best interests of society, so there is an inefficient allocation of scarce resources.
externality
externality is the cost or benefit a third party receives from an economic transaction outside of the market mechanism
external benefits
External benefit (positive externality): a benefit to a third party that is not involved in the making, buying/selling and consumption of a specific good/service.
External cost
External cost (negative externality): a cost to a third party that is not involved in the making, buying/selling and consumption of a specific good/service.
Private cost
Private costs are the costs to economic agents involved directly in an economic transaction.
Social cost
This is calculated by private costs plus external costs. It is the cost to society as a whole
What’s the difference between private costs and external costs?
Private costs are cost that are incurred by buyers or sellers in a market transaction. For example, when a consumer buys a pint of milk the cost to the consumer is the price and the cost to the producer is the cost of production. External costs are costs incurred by third parties to a market transaction. Pollution emitted by a factory is an example of an external cost of production.
What’s the difference between private benefits and external benefits?
Private benefits are benefits that arise to buyers or sellers in a market transaction. For example, when a consumer buys a car the benefit to the consumer is the utility gained from access to ca travel. External benefits are benefits gained by third parties to a market transaction. An example of an external benefit to beekeeping is the pollination provided to local farmers.
Social benefit
Social benefits are private benefits plus external benefits.
Public goods
Non excludability
Non rivalry
means that consumption of a product does not prevent another person from also consuming that product, e.g. a radio programme demonstrates non-rivalry, because if one person listens to the programme it does not prevent another person from also listening to it. However, the radio itself is a rival good.
free-rider problem
free-rider problem is a type of market failure that occurs because everybody is able to benefit from public goods. Free riders are a problem because while not paying for the good, consumers may continue to access/use it. Thus, the good is likely to be under-provided or not provided at all.
Private good
rival and excludable
