Chapter 4: Market Failures, Public Goods And Externalities Flashcards
Demand-side market failures
- impossible to charge consumers what they wanna pay
- they can get benefits for free
Supply-side failures
- firm doesn’t have to pay full cost of production
- external costs of production aren’t reflected in the supply
Factors of efficiently functioning markets
1- the demand curve must show the consumers’ full willingness to pay
2- supply curve must show full production costs
If the conditions of an efficient market hold…
The market will produce only units where benefits are equal to costs and maximize the amount of “benefit surpluses” that are shared between consumers and producers
Consumer surplus
- Difference between what a consumers willing to pay and what they actually pay
- extra benefit from paying less than max price
Producer surplus
- difference between the actual price a producer receives and the minimum price they’d accept
- extra benefit from receiving a higher price
Productivity efficiency is achieved by
Producers using the best technologies and combinations of resources available, minimizing the per-unit-cost of the output produced
Allocative efficiency
Correct quantity of products is produced relative to other goods and services
Allocative efficiency occurs at the market equilibrium quantity with 3 conditions existing…
1- MB (marginal benefit)= MC (marginal cost)
2- max willingness to pay= minimum acceptable price
3- total surplus (consumer and producer surplus) is at max
Private goods
- offered for sale in stores
- rivalry (one person buys another can’t have that product)
- excludability (people who don’t pay get no benefit)
- no underproduction or overproduction
Public goods
- provided by government for free
- nonrivalry
- nonexcludability
- free-rider problem (nonpayers enjoy benefit)
Free riding
- willingness to pay of free riders not expressed in market
- more free riding less demand
- lack of demand means private firms can’t profit from public goods
- private firms don’t produce them so society suffers efficiency losses (the goods’ mb exceeds mc)
- if the private firms can afford the production costs, they’ll produce them
How does society determine the optimal amount of a public good if they can’t see the demand for it?
- the government has to try and estimate the demand with surveys/votes
- mb must = mc
Cost-benefit analysis
Comparison of marginal costs and benefits
Cost of public goods
- resources diverted from private good production
- private goods that won’t be produced
Benefit of public goods
Extra satisfaction
Economy in government is not…
Reduced government spending
Economy in government is…
Allocating resources between private and public sectors to achieve max net benefit
Quasi public goods
-Government-provided goods and services that could possibly exclude
Reallocation system
Government uses taxes to reallocate resources from private goods to production of quasi and public goods
Externalities
Cost or benefit accruing to a third party that is external to the market transaction
Negative externalities
- detrimental effects
- too much produced
- supply side failures
Positive externalities
- effects benefit
- too little produced
- demand side failures
How does government correct negative externalities?
1- private bargaining 2- liability rules and lawsuits 3- tax on producers 4- direct controls 5- market for externality rights
How does the government correct positive externalities?
1- private bargaining
2- subsidy to consumers
3- subsidy to producers
4- government provision
Direct controls
Pass legislation to limit activity (I.e. Raise cost of production)
Government role in economy
- correction of externalities
- officials must identify existence and cause
- has to be done in context of politics
