2.8 - Market failure and externalities Flashcards
What is market failure?
Market failure happens when the price mechanism fails to efficiently allocate the scarce resources to where they are best suited.
When are resources misallocated?
Resources are misallocated when they are not devoted to the use that will give society the most welfare.
What is complete market failure?
Complete market failure happens where, unless the good or service is provided outside the mechanism, there wouldn’t be a market for it.
What is partial market failure?
Partial market failure happens when the private sector may partially provide it but at the wrong price or quantity.
Why is producing and consuming at the wrong price and quantity bad for society?
This is because resources could be better used to improve welfare.
What do some goods affect when they are produced or consumed?
Some goods affect third parties (not the producer or the consumer) when produced or consumed. The effects are called externalities.
What two categories can the benefit of a good be split into?
Private and external benefits.
What two categories can the cost of a good be split into?
Private and external cost.
How are private benefits accounted for and observed by?
The market.
Why are the external consequences of a good often ignored?
The asymmetry of information can often cause the external consequences of consuming a good to be ignored.
What happens as a result of the externalities being ignored?
We see over/under consumption or over/under production of some goods in the free market. This is a source of market failure.
What does the social benefit equal?
The social benefit is equal to the sum of the external and private benefits.
What is the socially optimum quantity?
The socially optimal quantity is where it is allocatively efficient to produce and consume.
What is the difference between the social benefit and the private benefit called?
The external benefit.
What does the social and private curves being parallel mean?
The external benefit is constant.
