Market Failure & Externalities Flashcards
What is market failure?
Market failure- too much/too little of 🚘 produced/consumed compared with socially optimal level of output- OR WHEN price mechanism-> inefficient allocation of resources-> net welfare loss
What is an externality?
Externality- costs or benefits external to exchange (3rd party effects)
What is external cost also known as?
Negative externality
What is external benefit also known as?
Positive externality
What is an external cost?
External Costs (negative ➖ externality)- cost to 3rd party (✖️ involved in making, buying/selling & consumption of specific 🚘 /🧹)- cost outside market transaction
What are examples of external costs in production?
Production examples: Burning 🥵 coal in power stations for electricity⚡️-> global warming
What are examples of external costs in consumption?
Consumption examples: driving a 🚙-> congestion, pollution, slower journey times for others etc
What is an external benefit?
External Benefits (positive ➕ externality) - benefit to 3rd party (✖️ involved in making, buying/selling & consumption of specific 🚘 /🧹 – benefit outside market transaction
What are examples of external benefits in production?
Production examples: use of renewable energy sources e.g. wind 💨 turbines & tidal 💧 power to create electricity⚡️-> ⬇️ carbon emissions emitted
What are examples of external benefits in consumption?
Consumption examples: cycling 🚴♀ to work-> ⬇️ congestion, ⬇️ air & noise pollution etc
What is a private cost?
Private Cost- cost to producers (mainly) & consumers in market transaction
What are examples of private costs?
Example: wages 💵 for workers, electricity⚡️/gas⛽️ costs & cost of 🚘/🧹 for consumer
What is a private benefit?
Private Benefit- benefit to producers & consumers (mainly) in market transaction
What is the social cost equal to?
Social Cost- private cost ➕ external cost
What is the social benefit equal to?
Social Benefit- private benefit ➕ external benefit
Describe how to draw a diagram showing external costs
1) Draw upwards facing MPC curve
2) Draw upwards facing MSC curve slightly above it stemming from the same point of origin as the MPC curve
3) The gap between the MSC & MPC curves indicates the external cost
Describe how to draw a diagram showing external benefits
1) Draw downwards facing MPB curve
2) Draw downwards facing MSB curve slightly above it stemming from the same point of origin as the MPB curve
3) The gap between the MSB & MPB curves indicates the external benefit
What does the external cost diagram show?
External costs ⬆️ disproportionately with output when MSC & MPC curves diverge (separate)
External costs grow at faster rate with output because curves diverge than they would if the MPC & MSC curves were parallel (External costs ⬆️ proportionately with output when MSC & MPC curves parallel)
What does the external benefit diagram show?
External benefits ⬆️ disproportionately with output when MSB & MPB curves diverge (separate)
External benefits grow at faster rate with output because curves diverge than they would if the MPB & MSB curves were parallel (External benefits ⬆️ proportionately with output when MSB & MPB curves parallel)
What are examples of private benefits?
Example: 🚴♀ -> saving 💵 on bus 🚎 fare & 💰 for firms from selling 🚘/🧹
