Definitions
What is market Failure
This term describes a situation where markets fail to allocate resources efficiently.
What is a demerit good?
good that is over produced and over consumed in a market.
produces negatuve externalities
consumers understimate the harm
WHY do social costs end up higher than private costs when negative side-effects occur?
because external costs are added to private costs but are not paid for by the consumer.
WHY won’t private companies provide public goods like street lighting?
Because they can’t charge users and therefore cannot earn a profit.
What are external costs?
These are costs borne by a third party, not the producer or consumer.
social cost
private cost + external cost
HOW do external benefits affect the total benefits society receives?
They increase social benefits beyond the private benefits of the consumer.
HOW does the free-rider problem lead to a missing market for public goods?
People use the good without paying, so firms won’t supply it at all.
What are external benefits?
These are benefits enjoyed by society beyond the private benefit
profit driven production
When firms only produce goods that earn a profit, this leads to under-production of beneficial goods.
WHY is it important to consider social benefits instead of just private benefits?
Because private benefits ignore positive impacts on third parties, causing under-consumption of beneficial goods.
WHY does the government often step in to provide public goods?
Because the private sector fails to provide them, leaving society without essential services.
What are private benefits/costs?
Benefits or costs to the individual directly involved in a transaction. or economic activity
what are negative extrenalities
costs imposed on a third party who did not choose to incur that cost, resulting from an economic activity
HOW does adding external costs to private costs change the outcome for society?
It shows society pays a higher total cost than the producer or consumer realises.
HOW do public goods contribute to market failure?
They cause a missing market, since the market mechanism does not supply them.
What are social benefits?
private benefit + external benefit.
what are public goods and how do they cause market failure
hese are non-excludable and non-rivalrous. The "free-rider problem" reduces the incentive for private provision of goods like national defense or streetlights, leading to under-provision.
WHY does ignoring external costs lead to market failure?
Because firms produce too much of harmful goods, causing overproduction and misallocation of resources.
WHY is street lighting considered a classic example of market failure?
Because it is a non-profitable public good, so the private sector will not provide it even though society needs it.