Market Failure and externalities

Question 1

Define the costs of Market Failure MPC, MSC, MEC

Answer 1

Costs:
* MPC = The cost to a firm of producing one extra unit
* MSC = The extra cost to society per extra unit consumed (Marginal external cost + Marginal Private cost)
* MEC = The difference between private costs and social costs

Question 2

Explain using a diagram, negative externalities of consumption and production

Answer 2

Externality = The cost or benefit a third party recieves from the consumption or production of a good.

Negative externality:
* Caused by demerit goods (a good which can have a negative impact on the consumer/third party)
* Usually associated with information failure as consumers/producers do not understand the long run implications of the good/service.
* Example - Cigarettes, bad for the consumers lungs, and can implicate a third party through second hand smoking.

Question 3

Explain using a diagram, positive externalities of consumption and production

Answer 3

Positive Externality:
* Caused by merit goods
* Also associated with information failure as, consumers do not understand the long run benefits of consuming the good, and therefore:
* They are underconsumed and therfore underprovided in the free market.
* E.G. Education, and therefore governments usually have to step in to provide this.
* Positive externality to the third party of education is a more skilled workforce.

Question 4

Define Market Failure

Answer 4

When the free market fails to allocate resources to the best interests of society and therefore there is an innefficient allocation of resources.

Question 5

Define the Benefits MSB, MPB, MEB

Answer 5

Benefits:
* MPB = The extra benefit on the irm per one extra unit produced
* MSB = The extra benefit on socety per one extra unit consumed. (Marginal external benefit + Marginal private benefit)
* MEB = The difference between the priate benefit and the social benefit.