2.8.1 - Market Failure - Externalities

Question 1

Define market failure

Answer 1

When marginal social costs do not equal marginal social benefits; when the free market does not maximize the welfare of a countries citizens.

Question 2

Define externalities

Answer 2

Any impact that the production or consumption of a good or service has on a third party.

Question 3

Define Negative externalities or external costs

Answer 3

Spillover costs that negatively impact third parties resulting from producing or consuming a good or service.

Question 4

Define Positive externalities or external benefits

Answer 4

Spillover benefits that positively impact third parties as a result of the consumption or production of a good ro service.

Question 5

Define productional external costs

Answer 5

Spill-over costs of third parties that come from the production of a good or service

Question 6

Define marginal private costs

Answer 6

factors of production used in producing a good or service. Each extra unit produced is a marginal private cost.

Question 7

Define marginal social costs

Answer 7

Marginal private cost + external cost = Marginal social cost

MPC + external cost = MSC

Question 8

Draw the diagram for production external cost

Answer 8

Question 9

Explain this diagram

Answer 9

• The market output is set where MPB = MPC at output Q and price P
• The socially efficient output is at MSB = MSC at output Q* and price P*
• A welfare loss occurs when output for a good or service means MSC is greater than MSB.
• For each extra unit produced beyond Q*, the cost to society is greater than the benefit.

Question 10

Define consumption external costs

Answer 10

Spill-over costs of third parties that come from the consumption of a good or service

Question 11

Define marginal private benefits

Answer 11

The utility an individual receives from consuming a good or service.

Question 12

Define marginal social benefits

Answer 12

MPB + external benefit = MSB

Question 13

Draw the diagram for consumption external cost

Answer 13

Question 14

Explain this diagram

Answer 14

• The market output is set where MPB = MPC at output Q and price P
• The socially efficient output is at MSB = MSC at output Q* and price P*
• A welfare loss occurs when output for a good or service means MPB is greater than MSB.
• For each extra unit produced beyond Q*, the cost to society is greater than the benefit.

Question 15

Define production external benefits

Answer 15

Production external benefits are the spill-over benefits that occur as a result of the production of a good or service.

Question 16

Draw the graph for production external benefits

Answer 16

Question 17

Explain this diagram

Answer 17

• The market output is set where MPB = MPC at output Q and price P
• The socially efficient output is at MSB = MSC at output Q* and price P*
• A welfare loss occurs when output for a good or service means MSC is lesser than MSB.
• This is a market failure because there is an under-allocation of resources

Question 18

Define consumption external benefits

Answer 18

Consumption external benefits occur when a good or service is consumed and there are spill-over benefits on third parties.

Question 19

Draw the diagram for consumption external benefits

Answer 19

Question 20

Explain

Answer 20

• The market output is set where MPB = MPC at output Q and price P
• The socially efficient output is at MSB = MSC at output Q* and price P*
• A welfare loss occurs when output for a good or service means MSB is greater than MSC.
• This is a market failure because there is an under-allocation of resources