Market Failures: Public Goods and Externalities 5 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Dec 19, 2015
Market Failures: Public Goods and Externalities5McGraw-Hill/IrwinCopyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Market FailuresMarket fails to produce the right amount of the productResources may beOver-allocatedUnder-allocatedLO1
Demand-Side FailuresImpossible to charge consumers what they are willing to pay for the productSome can enjoy benefits without paying
LO1
Supply-Side FailuresOccurs when a firm does not pay the full cost of producing its outputExternal costs of producing the good are not reflected in the supplyLO1
Efficiently Functioning MarketsDemand curve must reflect the consumers full willingness to paySupply curve must reflect all the costs of productionLO1
Consumer SurplusDifference between what a consumer is willing to pay for a good and what the consumer actually paysExtra benefit from paying less than the maximum priceLO2
Consumer SurplusLO2LO2DQ1P1
Producer SurplusDifference between the actual price a producer receives and the minimum price they would acceptExtra benefit from receiving a higher price
LO2
Producer SurplusLO2LO2S
Efficiency RevisitedLO2SQ1P1D
Efficiency LossesLO2cSQ1Q2Dbdae
Efficiency LossesLO2cSQ1Q3DbfagQuantity (bags)
Price (per bag)
Private GoodsProduced in the market by firmsOffered for saleCharacteristicsRivalryExcludabilityLO3
Public GoodsProvided by governmentOffered for freeCharacteristicsNonrivalryNonexcludabilityFree-rider problemLO3
Cost-Benefit AnalysisCost Resources diverted from private good productionPrivate goods that will not be producedBenefitThe extra satisfaction from the output of more public goods
LO3
ExternalitiesA cost or benefit accruing to a third party external to the transactionPositive externalitiesToo little is producedDemand-side market failuresNegative externalitiesToo much is producedSupply side market failuresLO4
Government InterventionCorrect negative externalitiesDirect controlsSpecific taxesCorrect positive externalitiesSubsidies Government provision
LO4
Government InterventionLO4(a)Negative externalitiesDSStOverallocationNegativeexternalitiesQoQeacb(b)Correct externality with taxDSStQoQeaT
Government InterventionLO4
Methods for Dealing with ExternalitiesProblemResource Allocation OutcomeWays to CorrectNegative externalities (spillover costs)Overproduction of output and therefore overallocation of resourcesPrivate bargainingLiability rules and lawsuitsTax on producersDirect controlsMarket for externality rightsPositive externalities (spillover benefits)Underproduction of output and therefore underallocation of resourcesPrivate bargainingSubsidy to consumersSubsidy to producersGovernment provision
Governments Role in the EconomyGovernment can have a role in correcting externalitiesOfficials must correctly identify the existence and causeHas to be done in the context of politicsLO5
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