Failure of Markets Flashcards
Define externalities (spillovers)
The impact on third parties of a transaction between others
Give 3 examples of external costs
- Air and water pollution
- Texting while driving
- Chemical runoff that affects fish stocks
Give 3 examples of external benefits
- Education
- Beehives next to almond orchards
- Preserved farmland
Define market failure
Free market equilibrium not providing the socially optimal amount of a good. (e.g. When a market economy is left to itself, it will typically generate too much pollution because polluters have no incentive to take into account the costs of their work)
Why isn’t the optimal quantity of pollution not zero?
Because it’s a side effect of useful activities
What is the marginal social cost of pollution?
The additional cost imposed on society as a whole by an additional unit of pollution. (e.g. Acid rain, smog, contaminated water, etc.)
What is the marginal social benefit of pollution?
The additional gain to society as a whole from an additional unit of pollution. (e.g. Goods and services, jobs, etc.
What is the socially optimal quantity of pollution?
The quantity of pollution that society would choose if all the costs and benefits of pollution were fully accounted for
Define external benefit
A benefit that an individual or firm confers on others without receiving compensation
Define technology spillover
An external benefit that results when knowledge spreads among individuals and firms
What happens to the market when the consumption (or production) of a good generates negative external costs?
Tends to produce too much of the good than efficiency requires, since the market does not take into account the negative external costs from the consumption of the good.
What happens to the market when the consumption (or production) of a good generates positive external costs?
Tends to produce too little of the good of it than efficiency requires, since the market does not take into account the positive external benefits from the consumption of the good
How does Coase Theorem provide a solution to externalities?
States even in the presence of externalities, an economy can always reach an efficient solution provided that the transaction costs are sufficiently low
What 2 characteristics can classify goods?
- Whether they’re excludable
* Whether they’re in rival consumption
When is a good non-excludable?
If the supplier can’t prevent consumption by people who don’t pay for it.
