Chapter 8 - Market failure and externalities

• What is market failure?

  When a market allocates resources inefficiently
• What causes market failure?

  Externalities are an important cause
• What is a 'missing market'?

  When no market exists for a good/service
• How does the provision of healthcare illustrate partial market failure?

  Some cannot afford necessary treatment
• What are externalities?

  Effects on third parties from production/consumption
• What are third parties in the context of externalities?

  People not involved in the transaction
• What are positive externalities?

  External benefits to a third party
• What are negative externalities?

  External costs to a third party
• What is a private cost?

  Cost incurred by a consumer or firm
• What are external costs?

  Costs caused by externalities
• What is social cost?

  Full cost borne by society
• What is a private benefit?

  Benefit gained by a consumer or firm
• What are external benefits?

  Benefits caused by externalities
• What is social benefit?

  Full benefit received by society
• Why does market failure occur?

  External costs and benefits are ignored
• What is marginal private cost (MPC)?

  Cost of producing the last unit of a good
• What is marginal social cost (MSC)?

  MPC plus external cost
• What does it mean if MPC and MSC curves are parallel?

  External costs per unit produced are constant
• What does it mean if MPC and MSC curves diverge?

  External costs per unit increase with output
• What is marginal private benefit (MPB)?

  Benefit of consuming the last unit of a good
• What is marginal social benefit (MSB)?

  MPB plus external benefit
• What does it mean if MPB and MSB curves are parallel?

  External benefits per unit are constant
• What does it mean if MPB and MSB curves diverge?

  External benefits per unit increase with output
• What occurs at equilibrium in the free market?

  Supply and demand are equal
• What do consumers and producers ignore in the free market?

  Social costs and benefits
• What is the equilibrium output level?

  Where MPC equals MPB
• What is the socially optimum level of output?

  Where MSC equals MSB
• What does the socially optimal level of output provide?

  Maximum benefit of positive externalities
• What happens if negative production externalities are ignored?

  Leads to overproduction and underpricing
• What is welfare loss?

  Loss to society from ignoring externalities
• What happens if positive consumption externalities are ignored?

  Leads to underconsumption and underpricing
• What is potential welfare gain?

  Gain to society lost by ignoring externalities
• What happens if negative consumption externalities are ignored?

  Leads to overconsumption and welfare loss
• What is the impact of ignoring positive production externalities?

  Leads to underproduction and potential welfare loss
• How do property rights relate to externalities?

  Absence can cause negative externalities
• What happens when property rights are extended?

  Externalities can be accounted for
• What is the result of a lack of property rights?

  Overuse and environmental damage occur
• What is the relationship between education and positive externalities?

  Education increases workforce productivity
• What is the impact of healthcare on society?

  Improved health increases economic output
• What is the significance of externalities in market failure?

  They are a classic reason for market failure