Introduction to Market Failure

Question 1

What is market failure?

Answer 1

When the free market fails to achieve a socially optimal allocation of resources towards the production of a particular good or service. Either too much or too little of a particular good or service is produced.

Question 2

What is overprovision/overallocation?

Answer 2

When too many resources are allocated to the production of a good/service

Question 3

What is underprovision/underallocation?

Answer 3

When too little resources are allocated to the production of a good/service

Question 4

What are externalities?

Answer 4

An externality is when the actions of consumers or producers give rise to negative or positive side-effects on other people, who are not part of these actions

Question 5

What are marginal private costs (MPC)?

Answer 5

Marginal private costs refer to costs to producers for producing an additional unit of output

Question 6

What are marginal social costs (MSC)?

Answer 6

Marginal social costs refer to costs to society for producing an additional unit of output

Question 7

What are marginal private benefits (MPB)?

Answer 7

Refers to benefits to consumers from consuming an additional unit of good/service

Question 8

What are marginal social benefits (MSB)?

Answer 8

Refers to benefits to society from consuming an additional unit of good/service

Question 9

What is the relation between MPB, MPC, MSB, and MSC?

Answer 9

1. Negative externalities: MSC > MSB
2. Positive externalities: MSB > MSC
3. Consumption externalities: MSB & MPB
4. Production externalities: MPC and MSC

Question 10

What is welfare loss?

Answer 10

Welfare (or deadweight) loss is the total societal welfare lost due to market failure