#6 Market Failure | Flashcards
What are positive production externalities?
External benefits created by producers, where the social benefits (MSB) exceed the private benefits (MPB). Examples include training workers who provide benefits to society or firms engaging in R&D benefiting others.
Explain the welfare loss caused by positive production externalities.
Underprovision of goods with positive production externalities leads to welfare loss (triangle between MSB and MSC curves, Qm and Qopt). Society loses potential benefits from the unproduced goods.
How do subsidies correct positive production externalities?
A subsidy equal to the external benefit shifts the MPC curve downward (to align with MSC), increasing quantity from Qm to Qopt and reducing price from Pm to Popt.
Explain direct government provision as a policy to correct positive production externalities.
The government provides the good/service (e.g., R&D, worker training), shifting the MPC curve down to MSC and increasing quantity to Qopt and reducing welfare loss.
What are the strengths and weaknesses of subsidies in correcting positive production externalities?
Strengths: Reduces welfare loss, encourages production.
Weaknesses: Requires accurate calculation of external benefits and incurs government costs.
Why is underprovision of goods with positive production externalities a form of market failure?
The free market produces less than the socially optimal quantity (Qm < Qopt) due to lack of incentive for producers to account for external benefits.
What are the four key methods to correct positive externalities?
Legislation or advertising: Promotes behavior (e.g., compulsory education).
Direct government provision: Supplies the good directly (e.g., public education).
Subsidies: Reduces production costs to increase supply.
Nudges (HL only): Influences consumer behavior (e.g., bike lanes).
How does government legislation correct positive externalities?
Legislation mandates consumption or provision of goods (e.g., compulsory education).
Advertising raises awareness, encouraging consumption (e.g., health checkups).
Evaluation:
Advantages: Effectively increases demand.
Disadvantages: May be costly to implement; effectiveness depends on enforcement.
How do subsidies correct positive externalities?
Subsidies reduce production costs, shifting MPC downward to align with MSC.
Leads to higher output (Qm → Qopt) and lower price (Pm → Popt).
Evaluation:
Advantages: Encourages production and consumption.
Disadvantages: Requires tax revenue, opportunity cost of funds.
How does direct government provision correct positive externalities?
Government provides the good (e.g., public healthcare).
Shifts supply curve (MPC) downward, achieving allocative efficiency at Qopt.
Evaluation:
Advantages: Ensures provision.
Disadvantages: High cost; depends on government efficiency.
What are nudges, and how do they address positive externalities?
Nudges subtly influence behavior (e.g., bike lanes, graphic cigarette warnings).
Shifts MPB toward MSB, increasing consumption to Qopt.
Evaluation:
Advantages: Cost-effective; encourages voluntary behavior.
Disadvantages: Impact varies across demographics and cultural contexts.
Define merit goods. Why are they underprovided?
Merit goods: Goods with positive externalities, desirable for society (e.g., education).
Reasons for underprovision:
Consumer ignorance (unaware of benefits).
Low incomes (can’t afford).
External benefits not reflected in private demand.
How can governments address the underprovision of merit goods?
Legislation: Makes consumption mandatory (e.g., schooling).
Subsidies: Reduces costs for consumers or producers.
Direct provision: Government provides the goods.
Evaluate the effectiveness of policies for correcting positive externalities.
Direct provision/subsidies:
Pros: Increases consumption and production to Qopt.
Cons: High cost; opportunity cost of public funds.
Legislation:
Pros: Mandates provision; raises awareness.
Cons: Costly enforcement; may face resistance.
Nudges:
Pros: Cost-effective; encourages voluntary compliance.
Cons: Impact may be inconsistent.
Explain the welfare loss in a positive consumption externality
Welfare loss is the shaded triangle where Qm < Qopt.
External benefits are unutilized due to underconsumption.
Calculated as:
Height = External benefit (MSB - MPB).
Base = Underconsumption (Qopt - Qm).
Area = ½ × base × height.
