1.3

• market failure


  occurs when the market fails to allocate scarce resources efficiently, causing a loss in social welfare loss.
• types of market failure

  - externalities

  - under-provision of public goods

  - information gaps
• externalities


  the cost or benefit a third party receives from an economic transaction outside of the market mechanism
• consequence of externalities


  leads to the over or under-production of goods, meaning resources aren't allocated efficiently.
• externalities examples


  cars and cigarettes have negative externalities whilst education and healthcare have positive externalities.
• problem with public goods

  Public goods are non-rivalry and non-excludable, meaning they are underprovided by the private sector due to the free-rider problem
• information gaps


  in reality, consumers dont always have perfect information. Therefore, economic agents do not always make rational decisions and so resources are not allocated to maximise welfare.
• characterisitcs of public goods

  - non rival

  - non excludable
• non rival


  one person's use of the good doesn't stop someone else from using it.
• non excludable


  meaning that you cannot stop someone from accessing the good and someone cannot choose not to access the good.
• quasi-public good


  goods which aren't perfectly non-rival and non-excludable but aren't perfectly rival or excludable. E.g., roads.
• free rider problem


  - you cannot charge an individual a price for the provision of a non-excludable good because someone else will gain the benefit from it without paying anything.

  - A free rider is someone who receives the benefits without paying for it.

  - Private sector producers will not provide public goods to people because they cannot be sure of making a profit, due to the non-excludability of public goods.

  - Therefore, if the provision of public goods was left to the market mechanism, the market would fail and so they are provided by the

  - government and financed through taxation.
• private costs/benefits


  the costs/benefits to the individual participating in the economic activity.
• social costs/ benefits


  costs/benefits of the activity to society as a whole.
• external costs/benefits


  costs/benefits to a third party not involved in the economic activity. difference between private costs/benefits and social costs/benefits.
• merit good


  a good with external benefits, where the benefit to society is greater than the benefit to the individual.

  ® These goods tend to be underprovided by the free market.
• demerit goods


  is a good with external costs, where the cost to society is greater than the cost to the individual.

  ® They tend to be over-provided by the free market.
• marginal cost/benefit


  the extra cost/benefit of producing/consuming one extra unit of the good.
• marginal private benefit (MPB)


  the extra satisfaction gained by the individual from consuming one more of a good.
• marginal social benefit (MSB)


  the extra gain to society from the consumption of one more good.
• marginal private cost (MPC)


  the extra cost to the individual from producing one more of the good.
• marginal social cost (MSC)


  the extra cost to society from the production of one more good.
• negative production externalities


  - occur when social costs are greater than private costs.

  - will ignore the external costs involved in producing a good.

  - It will produce where MPB=MPC, the market equilibrium, at Q1P1. . At Q1, the costs to the society are higher than the benefits to society resulting in the loss of welfare equal to the shaded area.

  - The external cost at Q1 is equal to the line AB.

  - The economy should produce where MSB=MSC, the social optimum position, at Q2P2.

  - The difference between marginal social cost and the marginal private cost increases as output grows because external costs grow the more that people do something.

  
• positive consumption externalities


  - Positive externalities of consumption occur when social benefits are greater than social costs.

  - In the diagram, the market left to its own devices will produce where MPB=MPC, it will not consider the benefits to society so will produce Q1P1.

  - If the market considers all the benefits, it would produce where MSB=MSC at Q2P2.

  - The failure of the market to consider the external benefits has led to the misallocation of resources and so there is an underproduction of Q1-Q2. This leads to a welfare loss of the shaded area.

  - The line AB represents the external benefit. Again, the difference between marginal private benefit and marginal social benefit grows since external benefits grow the more people that undertake the activity.

  - Healthcare and education are two examples of positive consumption externalities.

  - It is difficult to work out the size of the externality as it tends to be placed on value judgements, since it is difficult to monetise external costs. Many externalities are involved with information gaps, as people are unaware of the full implications of their decisions.

  
• when do governments intervene

  to ensure the market considers the external costs and benefits.
• types of intervention


  -Indirect taxes and subsidies.® Taxes can be put on goods with negative externalities.® subsidies are put on goods with positive externalities.® These help to internalise the externalities, moving production closer to the social optimum position.-Tradable pollution permits.® These allow firms to produce up to a certain amount of pollution and can be traded amongst firms so give them choice whilst reducing the total level of pollution.-Provision of the good.® When social benefits are very high, the government may decide to provide the good through taxation.® They do this with healthcare and education.-Provision of information.® Since some externalities are associated with information gaps, the government can provide information to help people make informed decisions and acknowledge external costs.-Regulation.® This could limit consumption of goods with negative externalities, for example banning advertising of smoking etc.
• types


  - symmetric info

  - asymmetric info

  - advertising

  - information gaps
• symettric information


  occurs where buyers and sellers have potential access to the same information; this is perfect information.
• assymetric information


  ® when one party has superior knowledge compared to another.
• advertising impact on info gaps

  ® it is designed to change attitudes of the consumers to encourage them to buy the good.

  ® It could cause them to think the benefits are greater than they actually are.
• examples


  - drugs

  - pensions

  - financial services