Externalities Flashcards
When does a market fail?
When a market allocates resources inefficiently
How does a market fail?
When the price mechanism fails to allocate scarce resources efficiently
What does the government do for market failure?
The government often intervenes to try and prevent it
What can a market failure be?
Complete or partial
What is a complete market failure?
No market exists - “a missing market”
What is an example of complete market failure?
National Defense is an example of a missing market as there’s no market which allocates national defense
What is a partial failure?
When a market functions, but either the price or quantity supplied of a good/service is wrong
What is an example of partial failure?
The provision of healthcare
Who do externalities affect?
Third parties
What are externalities?
The effects that producing or consuming a good/service has on people who aren’t involved in the making, buying/selling and consumption of the good/service
What are positive externalities?
The external benefits
What are negative externalities?
The external costs to the third party
What is an example of negative production externality?
A negative externality of producing steel could be pollution that harms the local environment
What is an example of positive production externality?
Production of military equipment could be an improvement in the tech that benefits society
What is an example of negative consumption externality?
Consuming a chocolate could be litter that’s dropped on the street
What is an example of positive consumption externality?
Someone training to be a doctor
Why do market failures occur?
Externalities are ignored
What is the private cost?
The private cost is any cost that a person or firm pays in order to buy or produce goods and services
What are external costs?
External costs are caused by externalities
Social cost =
Private costs + External costs
What is a private benefit?
the gains or advantages that accrue directly to individuals or firms engaging in an economic activity.
What are external benefits?
Causes by externalities
Social benefit =
Private benefit + external benefits
Why does a market failure occur?
In a free market the price mechanism will only take into account the private costs and benefits, but not the external costs and benefits
