2.8: Market Failure and Externalities

• Market failure


  Occurs when a free market, free from any form of government intervention, fails to lead to the most efficient allocation of scarce resources
• Marginal Private Cost (MPC)


  Cost to a firm of producing the last unit of a good, effectively the supply curve of a good
• Marginal External Cost (MEC)


  Additional cost generated when one extra unit of output is produced
• Marginal Social Cost (MSC)


  Cost to the firm plus the external cost of producing the last unit of a good
• Marginal Private Benefit (MPB)


  Benefit to the individual of consuming the last unit of a good, effectively the demand curve for a good
• Marginal External Benefit (MEB)


  Additional benefit generated when one extra unit of output is produced
• Marginal Social Benefit (MSB)


  Benefit to the individual consuming the good, plus the external benefit of the last unit of a good
• Negative externalities of consumption

  Occurs when the social benefits are less than the private benefits in consumption e.g. passive smoking
• Positive externalities of consumption

  Occurs when the social benefits are greater than the private benefits in consumption e.g. inoculation
• Negative externalities of production

  Occurs when social costs are greater than private costs in production e.g. pumping sewage into a river
• Positive externalities of production


  Occurs when the social costs are less than private costs in production e.g. redevelopment of derelict industrial sites