Market Failure & Externalities

Question 1

What is market failure?

Answer 1

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

Question 2

What is an externality?

Answer 2

Externality- costs or benefits external to exchange (3rd party effects)

Question 3

What is external cost also known as?

Answer 3

Negative externality

Question 4

What is external benefit also known as?

Answer 4

Positive externality

Question 5

What is an external cost?

Answer 5

External Costs (negative ➖ externality)- cost to 3rd party (✖️ involved in making, buying/selling & consumption of specific 🚘 /🧹)- cost outside market transaction

Question 6

What are examples of external costs in production?

Answer 6

Production examples: Burning 🥵 coal in power stations for electricity⚡️-> global warming

Question 7

What are examples of external costs in consumption?

Answer 7

Consumption examples: driving a 🚙-> congestion, pollution, slower journey times for others etc

Question 8

What is an external benefit?

Answer 8

External Benefits (positive ➕ externality) - benefit to 3rd party (✖️ involved in making, buying/selling & consumption of specific 🚘 /🧹 – benefit outside market transaction

Question 9

What are examples of external benefits in production?

Answer 9

Production examples: use of renewable energy sources e.g. wind 💨 turbines & tidal 💧 power to create electricity⚡️-> ⬇️ carbon emissions emitted

Question 10

What are examples of external benefits in consumption?

Answer 10

Consumption examples: cycling 🚴‍♀‍ to work-> ⬇️ congestion, ⬇️ air & noise pollution etc

Question 11

What is a private cost?

Answer 11

Private Cost- cost to producers (mainly) & consumers in market transaction

Question 12

What are examples of private costs?

Answer 12

Example: wages 💵 for workers, electricity⚡️/gas⛽️ costs & cost of 🚘/🧹 for consumer

Question 13

What is a private benefit?

Answer 13

Private Benefit- benefit to producers & consumers (mainly) in market transaction

Question 15

What is the social cost equal to?

Answer 15

Social Cost- private cost ➕ external cost

Question 16

What is the social benefit equal to?

Answer 16

Social Benefit- private benefit ➕ external benefit

Question 17

Describe how to draw a diagram showing external costs

Answer 17

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

Question 18

Describe how to draw a diagram showing external benefits

Answer 18

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

Question 19

What does the external cost diagram show?

Answer 19

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)

Question 20

What does the external benefit diagram show?

Answer 20

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)

Question 21

What are examples of private benefits?

Answer 21

Example: 🚴‍♀‍ -> saving 💵 on bus 🚎 fare & 💰 for firms from selling 🚘/🧹