Market Failures and Externalitis Flashcards
What factors contribute to market failure?
Absent or weak property rights
Public goods / common property characteristics
Externalities
Type of market structure, e.g. monopoly or oligopoly - imperfect competition leads to regulated utilities
What is an externality
An externality is the uncompensated impact of one person’s actions on the wellbeing of another person
What is a positive externality
beneficial impact, e.g. a neighbour’s beautiful flower garden, biodiverse habitat
What is a negative externality
–adverse impact, e.g. noise from the A47, increased flooding risk from a development
Assumptions of a private agent
Agents are rational and only consider the private impacts of their actions
Why do externalities occur
Self-interested buyers and sellers neglect the external costs or benefits of their actions, so the market outcome is not efficient
Example of external costs of production
noise and air pollution from factories / energy utilities
Example of external costs of consumption
emissions from driving, noise pollution
Social benefit of consumption < private benefit
How do you calculate social cost
private + external cost
What is meant by “Internalizing the Externality”
Altering incentives so that agents take account of the external effects of their actions. When market participants must pay social costs, market equilibrium = social optimum.
Is the social cost caused by negative externalities greater or smaller than the private cost (and position on graph)
They are greater and the line shifts left and up
How to calulate marginal social cost
It is the triangle formed from the points between where 1. the msc cuts through the D
- where the PC cuts through the D (the original market equilibrium
- and the point formed by drawing a straight line up from the original market eq. to the MSC line
In the presence of a positive externality, what does the social value of a good include
private value – the direct value to buyers
external benefit – the value of the positive impact on bystanders
Why do we want to find the socially optimal Q
It is the quantity where welfare is maximised
What can we conclude if Q is lower or higher than the social optimum
At any lower Q, the social value of additional units exceeds their cost
At any higher Q, the cost of the last unit exceeds its social value.
What is the marginal social benefit? MSB
the benefit society receives when an additional unit of a commodity is produced
What is the MSC marginal social cost
the cost of producing an additional unit of a commodity that is paid by society.
When accounting for the social cost caused by production positive externalities, which way will the line shift
The cost (supply) line will shift down and right
When accounting for the social benefit caused by consumption positive externalities, which way will the line shift
The benefit (demand) line will shift upwards
Why worry about negative externalities
They externalities impose external costs / spillover costs, on third parties for which no appropriate compensation is paid. his means the market is not operating efficiently
Why are externalities a cause or market failure
the price mechanism does not account for the social costs / social benefits of production and consumption
how can externalities by internalised
through government intervention
Explain negative and positive externalities in terms of supply relative to the social optimum
Negative externalities: private markets over-supply relative to the social optimum
Positive externalities: private markets under-supply relative to the social optimum
Give examples of private costs of wind energy
Labour
installation
cost of land and planning permission
cost of manufacturing the turbines
