Market Failure and its Causes Flashcards
What is market failure?
Market failure occurs when the free operation of price mechanism fails to allocate resources efficiently.
What are externalities?
They are costs or benefits to third parties who are not directly involved in the production and consumption of a good.
What is marginal private cost?
It is the cost borne by the firm or consumers in producing / consuming an additional unit of good.
What is marginal external cost?
It is the cost to the third party who are not directly involved in the production and consumption of an additional unit of good. The cost is not reflected in the price of the good.
What is marginal social cost?
It is the additional social cost from the last unit of a good produced or consumed.
MSC = MPC + MEC where MEC is the marginal external cost.
What is marginal private benefit?
It is the benefit to the producer or consumers from the production or consumption of one or more good.
What is marginal external benefit?
It is the benefit to the third party who are not directly involved in the production and consumption of an additional unit of the good. The benefit is not reflected in the price of the good.
What is marginal social benefit?
It is the addtional social benefit from the production or consumption of the last unit of good produced or consumed.
MSB = MPB + MEB
What are negative externalities?
It is the cost to the third party who is not directly involved in the production and consumption of a good and such costs are not reflected in the price of the product.
What are the policies to correct negative externalities?
- Taxation
- Legislation/Rules and Regulations
- Public Education
- Tradeable permits
How would taxation work?
The government can impose an indirect tax of the amount equal to the marginal external cost (MEC) at the socially optimal output.
