Chapter 8: Market failure and externalities Flashcards
Define market failure
A situation in which the free market equilibrium does not lead to a socially optimal allocation of resources, such that too much or too little of a good is being produced and/or consumed
Define marginal social benefit
The additional benefit that society gains from consuming an extra unit of a good
Define marginal social cost
The cost to society of producing an extra unit of a good
Define externality
A cost or a benefit that is external to a market transaction, is therefore not reflected in market prices, and may affect third parties not involved in the transaction
Define private costs
Costs incurred by an individual (firm or consumer) as part of its production or other economic activities
Define external costs
Costs associated with an individuals (a firm or households) production or other economic activities, which are borne by a third party and are not reflected in market prices
Define social costs
The sum of private and external costs
Define social benefits
The sum of private benefits and external benefits
Define private benefits
The benefits received by an individual ( a firm or consumer) as part of its economic activity
Define external benefits
The benefits received by society ( a firm or a household) that accrues to a third party (firm or household) not engaged in that economic activity and which are not reflected in market prices
Define production externality
An externality that affects the production side of a market, which may be either positive or negative
Define welfare loss
The social loss incurred when the market equilibrium diverges from the social optimum ( where MSB = MSC) often referred to as the deadweight welfare loss
Define consumption externality
An externality that affects the consumption side of a market which may be either positive or negative
