2.8 Market failure and externalities

Question 1

What is market failure?

Answer 1

The free market doesn’t lead to a socially optimal allocation of resources. Either too much/too little of a good is being produce/consumed

Question 2

What is total market failure?

Answer 2

The free market fails to provide ANY of a good/service

Question 3

What is partial market failure?

Answer 3

The free market fails to allocate scarce resources efficiently

Question 4

What is productive efficiency?

Answer 4

Producing goods/services at the lowest possible average total cost
It occurs at any point on PPC

Question 5

What is allocative efficience?

Answer 5

The right amount of goods/services produced where consumer utility is maximised
It’s not possible to judge from the PPC

Question 6

What are externalities?

Answer 6

Costs/benefits that are external to a market transaction and isn’t reflected in market prices
A spillover effect where 3rd parties are affected by the actions of others

Question 7

What are private costs and private benefits?

Answer 7

• Cost of an activity incurred to an individual taking the particular action e.g. wages, raw materials
• The benefits of an activity to an individual directly taking the action e.g. profit, utility

Question 8

What are external costs and external benefits?

Answer 8

• The cost of an activity that are the consequence of externalities from a 3rd party e.g. pollution
• The benefits that are received by society as a consequence of externalities from a 3rd party e.g. lowered costs for local producers, roads

Question 9

What are social costs and social benefits?

Answer 9

• Private costs + external costs (the total costs)
• Private benefits + external benefits (the total benefits)

Question 10

How much are negative and positive externalities consumed?

Answer 10

Negative = overconsumed
Positive = underconsumed