market failure

• Externalities are costs or benefits that affect third parties who did not choose to be involved in an economic activity.
• On the graph, marginal social cost (MSC) and marginal private cost (MPC) are the supply curve
• On the graph, marginal social benefit (MSB) and marginal private benefit (MPB) are the deman curve slope
• The difference between MSB and MPB is the consumer surplus
• Consumer surplus = area above demand curve but below price line
• Producer surplus = area above price line but below supply curve
• Welfare loss from externalities = area between MPC and MSC curves
• Subsidy = subsidy on positive externality
• Pigouvian tax = tax on negative externality
• merit goods: goods with positive externality
• Public good: non rival, non excludable
• de-merit goods: goods with negative externality
• Free rider problem: people not paying for public good
• public goods are not provided by private markets because they cannot be priced or sold
• Common pool resource: non renewable resources that are difficult to exclude others from using
• Tragedy of the commons: overuse of common pool resources due to free riding
• government intervention to correct positive consumer externalities: subsidies + direct provisions- shift MSC curve to the right, education/awareness + legislation/regulation- shift MPB to the right (closer to Qopt)
• government intervention to correct positive production externalities: subsidies + direct provisions + legislation/regulation- shift MPC curve to the right
• market failure is when there is an imperfectly competitive market structure
• negative externality of production: MSC>MPC with difference being the external cost (eg. pollution)
• negative externality of consumption: MSB<MPB with the difference being the external cost, aka wellfare loss(eg. smoking)
• government intervention to correct negative consumer externalities: indirect tax- shift MPC/MSC curve to the left.(higher price for consumers and lower for producers), legislation/awareness- shifts MPB to the left
• government intervention to correct negative producer externalities: indirect(Pigouvian) tax- shift MPC curve to the MS(tax on the pollutant or product itself, raises cost of production), tradable permits/legislation
• all public goods are merit goods but not vice versa
• non rivalrous: one person's use does not reduce availability to others
• public good: non rivalrous and non excludable
• merit good: has positive welfare effects that are not reflected by the market price
• excludability: ability to exclude non payers from consuming good
• market failure: when the free market fails to allocate resources efficiently
• asymmetric information is when one party (consumer/seller) possesses more information than the other
• asymmetric information market failure: MSC =/= MSB
• AI: seller > buyer: higher price than socially efficient, overallocation of resources eg. house seller not being honest about the maintenance history
• AI: buyer > seller: lower price than socially efficient, under allocation of resources eg. health insurance customer lying about their lifestyle- pays less for insurance than they really should
• allocative efficiency is achieved when MPC=MSC (supply) and MPB=MPB (demand)
• allocative efficiency means no externalitiees
• positive externality: social benefit greater than private benefit
• market failure occurs if there are externalities
• negative externality: social cost greater than private cost