Market failure Flashcards
Define market failure
When there is a misallocation of resources in the free market due to the price mechanism failing to allocate these resources efficiently.
Where does the free market operate on an externality diagram and why?
Where MPC=MPB
Firms aim to profit maximise - if a producer knows the additional cost for each unit of product, they can set prices to cover these costs and ensure profitability.
Consumers are selfish and behave rationally according to traditional economics - they want to buy these products where they are receiving the most benefit and maximising their utility, so want to buy at MPB.
Define a negative externality and give an example
A cost imposed on a third party as a result of economic activity. Difference between the private cost and social cost of a decision.
e.g., environmental pollution, dumping, landfill
Define a positive externality and give an example
When the consumption or production of a good/service benefits a third party.
e.g., walking to work, you are reducing pollution and congestion which benefits third parties
e.g., education, although this is a private benefit you can benefit third parties by educating others and using your skills in a positive way (through work, creating economic growth)
