Market Failure - T1 Flashcards
When does market failure occur
Occurs when the price mechanism causes an inefficient allocation or resources so leads to net welfare loss
What are externalities
3rd party effects ignored by the price mechanism
Where do external costs occur
In production or consumption
Production: pollution of rivers causing extra cost for fishermen
Consumption: smoking, passive smoke
Social costs
Adding private costs to external costs
Private costs: wages, rent, raw materials, electricity, machinery
External benefits - examples
May occur In consumption or production
Production: recycling of waste materials reducing the waste for landfills sites
Consumption: vaccination
Social benefits
Adding private benefits to external benefits
External costs of production
- waste disposal firm dumping toxic waste at sea
- burning coal in power stations, adding to global warming
- increased production of biofuels, which destroy rain Forrest and increase food price
External costs of consumption
- excess alcohol which leads to vandalism
- increased road congestion around the expansion of Heathrow airport
- tobacco smoking
External benefits of production
- paper and glass recycling plant, reducing waste for landfill sites
- construction of the London cross rail project, increasing inwards investment and raising local property prices
- use of sustainable energy
External benefits to consumption
- education and training programs increase human capacity
- improving quality of garden, increases value of neighbours houses
- consumption of vaccinations
Social optimum equilibrium
Equilibrium level of output or price for a good is where MSC=MSB
External costs welfare loss
Triangle of welfare loss is created as MSC curve is rotated inwards
Welfare loss is what we are losing but we do not recognise it
External benefits and welfare gain
Triangle of welfare gain as MSB is rotated outwards
Welfare gain is what we are gaining but we do not recognise it
What happens due to external costs of production
Overproduction- market level exceeds social optimum
Underpricing - market level below social optimum price
Welfare loss- marginal cost > marginal benefit
Concerns about availability of resources for future generations
Pollution levels
Calls for government intervention
What happens due to external benefits
Underconsumption - since market level of output is lower than social optimum
Underpricing- free market price is below social optimum
Welfare loss - their is extra benefit that could be exploited
Concerns over long term implications
Calls for government intervention
