1.3 Market failure (types of market failure and externalities) Flashcards
What is market failure?
When the price mechanism leads to a misallocation of resources
What are the three causes of market failure?
- Externalities
- Under-provision of public goods
- Information gaps
What does market failure cause?
A loss in social welfare
What are externalities?
The cost or benefit a third party receives from an economic transaction outside of the market mechanism
Why is producing and consuming at the wrong price and quantity bad for society?
As resources could be better used to improve welfare
What can the benefits of a good be separated out into?
private benefits and external benefits
What can the costs of a good be separated out into?
private costs and external costs
What are private costs/ benefits?
the costs/benefits to the individual participating in the economic activity
What are social costs/benefits?
the costs/benefits of the activity to society as a whole
What are external costs/benefits?
the costs/benefits to a third party not involved in the economic activity
What are external costs/benefits the difference between?
private costs/benefits and social costs/benefits
What is the social benefit equal to?
external benefit + private benefit
What is the social cost equal to?
private cost + external cost
What are positive consumption externalities?
A ‘good’ externality created in the consumption of a good
What are negative production externalities?
A ‘bad’ externality created in the production of a good
What is a marginal cost/benefit?
the extra cost/benefit of producing/consuming one extra unit of a good
What is the marginal private benefit (MPB)?
the extra satisfaction gained by the individual from consuming one more of a good
What is the marginal social benefit (MSB)?
the extra gain to society from the consumption of one more good
What is the marginal private cost? (MPC)
the extra cost to the individual from producing one more of the good
What is the marginal social cost? (MSC)
the extra cost to society from the production of one more good
If the production externality is negative, what does this mean about the social costs in relation to the private costs?
the social cost is greater than the private cost
What is the deadweight welfare loss?
the welfare loss to society from the overproduction of something that has a negative production externality
