2.8 Market Failure

Question 1

What is market failure ?

Answer 1

market failure occurs when the market fails to deliver an efficient allocation of resources; the price mechanism fails to maximise social welfare

Question 2

What are the possible reasons for market failure ?

Answer 2

1) negative externalities
2) positive externalities
3) demerit-goods
4) merit goods
5) information failure
6) public goods
7) monopoly power

Question 3

What is an externality ?

Answer 3

An externality is a harmful effect imposed on, or beneficial effect enjoyed by, any 3rd party outside the economic transaction for which no compensation is paid

Question 4

What are negative externalities ?

Answer 4

• negative externalities are harmful effects imposed on 3rd parties outside the economic transaction for which no compensation is paid
• the market over-allocates resources if, at the market determined output, MSC > MSB

Question 5

What are positive externalities ?

Answer 5

positive externalities are beneficial effects for 3rd parties outside the economic transaction for which no payment is made
- the market under-allocates resources if, at the market determined output MSB > MSC

Question 6

What is marginal private costs(MPC)

Answer 6

the additional cost to producers of producing an additional unit of output