Market failure: Externalities Flashcards
Why can market failure occur?
-existence of externalities
-imperfect/asymmetric info
-underprovision of public goods
What is an externality?
-Spill over effects of consuming/producing a good received by third parties
-When consumers/ producers don’t consider these external effects, market failure can occur
Explanation of negative production externality diagram
-Market equilibrium occurs when the MPB curve intersects the MPC curve
-Due to external costs the MSC is greater than the MPC
-vertical distance between MPC and MSC level of external cost
-Socially optimal level of production is when MSC crosses MPB
-Market equilibrium leads to market failure (represented by the welfare loss triangle) because there is an overproduction of the good
- Each unit produced beyond Qopt produces a net welfare loss to society. MSC>MPB
Example of negative production externality
-Air pollution from factories
-Workers: face lung problems, less work , decreased productivity, decreased revenue, lower local GDP, increased absenteeism,loss of income
-Local firms: less customers, more migration from area , less revenue
-Property owners: decreased revenue from rent as people move out, property less valuable
-Users of NHS: increased wait times, higher usage due to increased lung problems, increased strain on services
Analysis of positive consumption externality
-market equilibrium occurs when MPB=MPC
-social benefits of consumption are greater than private
-market equilibrium leads to market failure because there is an underconsumption of the good
-If Qopt was consumed, social welfare would be maximised
-Each unit of good consumed beyond Qm leads to net welfare gain
-value of the good is valued too low by consumers- only considering themselves
example of positive consumption externality;
-A vaccine reduces transmission through herd immunity,
-increased employment thus increased output as general health improves
-decreased waiting time and resource usage of NHS
-Education leads to high quality work
Negative consumption externality
Example: sugar consumption leads to higher cost for NHS to treat diabetes
-Using car in central london leads to increased pollution causing health concerns
Positive production externality:
-reduce costs for other firms
-R&D, new technologies can be easily adopted by other firms, cost of future research falls
