5.1 Negative Externality in Production Flashcards
What is market failure?
Market failure occurs when the free market fails to allocate scarce resources at the socially optimum level of output.
What are negative externalities in production?
Negative externalities in production are costs to third parties as a result of the actions of producers, such as local residents inhaling toxic smoke or waste being dumped in nearby rivers.
Why does a free market lead to misallocation of resources with negative externalities in production?
In a free market, individual producers only consider their private costs of production and ignore the full social cost of their actions due to self-interest. This results in resources being allocated at the private equilibrium of P1 and Q1 in the market instead of the social optimum P* and Q, causing overproduction and overconsumption. This generates a welfare loss with society bearing more cost than benefit given the units beyond Q being produced.
What are negative externalities in consumption?
Negative externalities in consumption are costs to third parties as a result of the actions of consumers, such as passers-by inhaling second-hand smoke or individuals over-consuming fast food.
Why does a free market lead to misallocation of resources with negative externalities in consumption?
In a free market, individual consumers only consider their private benefits in consumption and ignore the full social benefit of their actions due to self-interest. This results in resources being allocated at the private equilibrium of P1 and Q1 in the market instead of the social optimum P* and Q, causing overconsumption and overproduction. This generates a welfare loss with society bearing more cost than benefit given the units beyond Q being produced.
What are positive externalities in consumption?
Positive externalities in consumption are benefits to third parties as a result of the actions of consumers, such as individuals consuming healthy food increasing their productivity at work and generating more tax revenues for the government.
Why does a free market lead to misallocation of resources with positive externalities in consumption?
In a free market, individual consumers only consider their private benefits in consumption and ignore the full social benefit of their actions due to self-interest. This results in resources being allocated at the private equilibrium of P1 and Q1 in the market instead of the social optimum P* and Q, causing underconsumption and underproduction. This generates a welfare loss with society losing out on units that are not produced beyond Q1 up to Q that would have generated more benefit to society than cost.
What are positive externalities in production?
Positive externalities in production are benefits to third parties as a result of the actions of producers, such as lower costs to third-party producers who poach highly trained and skilled workers from companies who have borne the cost of in-work training programmes.
Why does a free market lead to misallocation of resources with positive externalities in production?
In a free market, individual producers only consider their private costs of production and ignore the full social cost of their actions due to self-interest. This results in resources being allocated at the private equilibrium of P1 and Q1 in the market instead of the social optimum P* and Q, causing underproduction and underconsumption. This generates a welfare loss with society losing out on units that are not produced beyond Q1 up to Q that would have generated more benefit to society than cost.
