2.8 Market failure - externalities and common pool resources

• The socially optimal output is when the marginal social benefit (MSB) equals the marginal social cost (MSC). Also referred to as allocative efficiency.
• An externality occurs when the consumption or production of a good or service has an impact on a third party. This creates a gap between the MPC and MSC, or between MPB and MSB.
• Merit goods are private goods that are under-produced and under-consumed, in a free market. They are beneficial to the consumer and society as a whole.
• Demerit goods are private goods that are over-produced and over-consumed, in a free market. They have negative effects when consumed.
• Negative externalities of production is when a good or service generates a negative effect on a third party by it being produced. The cost of this is not factored into the cost of producing the good.

  
• Positive externalities of production is when a good or service generates a positive effect on a third party by it being produced. The cost of this is not factored into the cost of producing the good.

  
• Negative externalities of consumption is when a good or service generates a negative effect on a third party by it being consumed, which are not factored into the decision to consume the good.

  
• Positive externalities of consumption is when the consumption of a good or service generates a positive effect on a third party.

  
• Common pool resources are rivalrous but non-excludable. These are natural resources that are freely available to anyone to use at no cost. However, once they have been consumed, they can't be consumed again.
• Unsustainable production of common pool resources can create negative externalities.
• Governments can intervene in response to externalities and common pool resources by:

  • indirect taxes
  • carbon tax
  • legislation and regulation
  • education
  • tradable permits
  • international agreements
  • collective self-governance
  • subsidies
  • government provision
• Challenges faced in international cooperation:

  • lack of shared responsibility
  • inequality of resources
  • political disagreements