Microeconomics Market Failure and Government Intervention

Question 1

Market failure

Answer 1

a situation in which the free market mechanism does not lead to an optimal allocation of resources, e.g. where there is divergence between marginal social benefit and marginal social cost

Question 2

Marginal social cost (MSC)

Answer 2

the cost to society of producing an extra unit of a good

Question 3

Marginal social benefit (MSB)

Answer 3

the additional benefit that society gains from consuming an extra unit of a good

Question 4

Externality

Answer 4

a cost or a benefit that is external to a market transaction, and is thus not reflected in market prices

Question 5

Consumption externality

Answer 5

an externality that affects the consumption side of a market, which may be either positive or negative

Question 6

Production externality

Answer 6

an externality that affects the production side of a market which may be either positive or negative

Question 7

Private cost

Answer 7

a cost incurred by an individual (firm or consumer) as part of its production or other economic activities

Question 8

External cost

Answer 8

a cost that is associated with an individual’s (a firm or household’s) production or other economic activities, which is borne by a third party