2.8 Market failure and externailities

• Externalities - when the decision of an individual has an impact on a third party. (e.g. consumption of coke > Diabetes > NHS)
• Private cost: Cost to an individual/firm
• Private benefit: Benefit to an individual/firm
• External cost: Cost to a third party (not involved in the decision to consume or produce)
• Marginal Social Cost: Marginal private cost + marginal external cost (overall cost to society producing the last unit of a good). If MSC is the same as the marginal private cost there is no externality.
• Marginal Private Cost: Cost of producing the last unit of a good to an individual/firm.
• Marginal Social Benefit: Marginal private benefit + marginal external benefit (overall benefit to society of producing the last unit.)
• Marginal External Benefit: benefit of producing the last unit to a third party.
• Marginal Private Benefit: Benefit of producing the last unit to and individual/firm
• Positive Externality of Consumption: Consumption of a good leads to positive externalities and underconsumption
• Positive Externality of Production: Production of a good leads to positive externalities and underproduction
• Negative Externality of Consumption: Consumption of a good leads to negative externalities and overconsumption.
• Negative Externality of Production: Production of a good leads to negative externalities and overproduction
• Marginal Social Benefit=MEB+MPB
• Diagram to show positive consumption externality

  A) MSC

  B) MSB

  C) MPB

  D) MARKET FAILURE

  
• Diagram to show negative consumption externality

  A) MSC

  B) MPB

  C) MSB

  D) Market Failure

  
• Diagram to show negative production externality

  A) MSC

  B) MPC

  C) MSB

  D) Market failure

  
• Diagram to show positive production externality

  A) MPC

  B) MSC

  C) MSB

  D) Market failure

  
• Externalities

  The cost or benefit a third party receives from an economic transaction outside of the market mechanism.
• Marginal external benefit

  The extra benefit to a third party not involved in the economic activity, per unit consumed.
• Marginal external cost

  The extra cost to a third party not involved in the economic activity, per unit consumed, expressed by: marginal social cost- marginal private cost.
• Marginal private benefit

  The extra benefit to the individual per unit consumed.
• Marginal private cost

  The extra cost to the individual per unit consumed.
• Marginal social benefit

  The extra benefit to society per unit consumed, expressed by: marginal external benefit + marginal private benefit.
• Marginal social cost

  The extra cost to society per unit consumed, expressed by: marginal external cost + marginal private cost.
• Market failure

  When the free market fails to allocate resources to the best interest of society, so there is an inefficient allocation of scarce resources.
• Positive externalities of production

  Where the social costs of producing a good are larger than the private cost of producing that good.
• Positive externalities of production

  A) MPC

  B) MSC

  C) Price

  D) Quantity

  E) MPB = MSB

  F) Positive externality of production

  G) ABE

  H) MSB=MSC

  I) MPC = MPB

  
• Positive externalities of consumption

  Where the social benefits of consuming a good are larger than the private benefits of consuming that good.
• Positive externalities of consumption

  A) MPB

  B) MSB

  C) MSC = MPC

  D) Price

  E) Quantity

  F) Positive externality of consumption

  G) MPB =MPC

  H) MSB = MSC

  I) ABE

  
• Negative externalities of production

  Where the social costs of producing a good are less than the private costs of producing the good.
• Negative externalities of consumption

  Where the social costs of consuming a good are less than the private costs of producing the good.
• Negative externalities of production

  A) MSC

  B) MPC

  C) MPB = MSB

  D) Quantity

  E) Price

  F) Negative externality of production

  G) MPB = MPC

  H) MSC = MSB

  I) ABE

  
• Negative externalities of consumption

  A) MSC = MPC

  B) MPB

  C) MSB

  D) Quantity

  E) Price

  F) MPB = MPC

  G) MSB MSC

  H) ABE