7.4 Private costs and benefits, externalities and social costs and benefits Flashcards
What is market failure?
This is when the price mechanism leads to an inefficient allocation of resources and a deadweight loss of economic welfare
What are some of the reasons for market failure?
Negative externalities and Positive externalities
Public goods - free rider problem and profit-motivated firms
Merit goods and De-merit goods - information failure
Information failures
Monopolies - one dominant seller and high barriers to entry
Immobility of factor inputs - suppliers can’t produce extra output or workers are immobile
Income inequality
What is an externality?
It is the cost or benefit a 3rd party receives from an economic transaction outside of the market mechanism. In other words, it is the spill-over effect of the production or consumption of a good or service.
What is the under provision of public goods?
Public goods are non-excludable and non-rivalrous and they are underprovided in the free market because of the free rider problem
What are information gaps?
It is assumed that consumers and producers have perfect info when making economic decisions. However, this is rarely the case and imperfect info leads to a misallocation of resources.
What are monoploies?
Since consumers have very little choice where to buy goods and services offered by monopolies, they are often overcharged. This leads to the underconsumption of the good or service and thus there is a misallocation of resources, since consumers needs and wants aren’t fully met
What is inequalities in the distribution of income and wealth?
There is an unequitable distribution of income and wealth. Income refers to a flow of money, while wealth refers to a stock of assets. This can lead to negative externalities and social unrest
What is complete and partial market failure?
Complete market failure occurs when there is a missing market. The market doesn’t supply the products at all. Partial market failure occurs when the market produces a good, but it is the wrong quantity or the wrong price. Resources are misallocated where there is a partial market
What are positive externalities?
They create external benefits. These are caused by merit goods. They are underprovided in the free market.
MSB>MSC
What are negative externalities?
They create external costs. They are caused by demerit goods. They are usually overprovided
MSC>MSB
What are private costs?
Those costs that are incurred by an individual who produces a good or service.
This determines how much the producer will supply
What is marginal private cost? MPC
It is the cost to a firm of producing one extra unit
What is a social cost?
The total costs of a particular action.
This is calculated by the private cost + external costs
What is the marginal social cost?
It is the extra cost on society derived per extra unit consumed.
It can be seen that MSC and MPC diverge from each other.
MSC = MPC + MexternalC
What is a private benefit?
benefits that go to individuals who produce or consume a particular good.
Could also be a firms revenue from selling a good
What is a social benefit?
These are private benefits + external benefits
What is a marginal social benefit?
It is the extra benefit on society derived per extra unit consumed
MSB = MPB + MexternalB
What are examples of negative production externalities?
MSC > MPC
- Industrial pollution of the water and air
- Climate change from greenhouse gases
- Resource depletion
- Deforestation
- Resource degradation
What would be some negative production externalities solutions?
COMMAND
* limit the emission of pollutants by setting a maximum level of pollutants permitted
* limit the quantity of output produced by the firm
* require polluting firms to install technologies reducing emissions
MARKET
* A tax per unit of output that directly corrects the overallocation of resources to the good.
* A tax on emissions creates incentives for the firm to buy fewer polluting resources and to switch to less polluting technologies (alternative energy sources); a contemporary example is carbon taxes.
* Tradable permits (“cap and trade”) puts a limit (“cap”) on the number of permits but allows firms to trade permits with each other, creating a market for permits.
What are some Negative production externalities analysis points?
Firms are ignoring full social cost because of self-interest. They are only looking at private cost and that is why they produce at p1 q1 which is the private optimum instead of the social optimum. The result of this is the overproduction of the good. The price is too low at P1 as it is only accounting for the private costs and not the external costs. That makes the whole problem worse as it encourages overconsumption of the good and then you see a misallocation of resources which gives you a welfare loss
What are examples of negative consumption externalities?
MSB < MPB
Demerit goods like alcohol, cigarettes, gambling, unhealthy foods, and certain drugs.
Pollution from individual behaviours such as automobile travel or littering.
Excessive sugary drinks / fast food
What would be some negative consumption externalities solutions?
Indirect taxes
Help and schemes to quit
Provide more info and education
What are some Negative consumption externalities analysis points?
The market will allocate at the private optimum at p1 q1 but society would like resources allocated at MSB = MSC the social optimum. Too much is being produced which leads to an overconsumption. If there is allocative inefficiency there will be a welfare loss.
Consumers are ignoring the social benefits of their actions, only considering private benefits due to their self-interest. The end result is allocating resources at the wrong place which leads to overconsumption and production of these goods. As a result, there is a misallocation of resources which leads to allocative inefficiency and a welfare loss to society
What are examples of Positive Production Externality?
MSC < MPC
- Education of workers by a firm useful outside of the firm such as first aid, CPR, literacy, and numeracy.
- Research and Development (“R&D”) done by firms - other firms can copy
