Market Failures and Externalities

1. Market Failures and Externalities Unit 2: How Markets Work

2. Sometimes markets are not able to provide the goods and services desired by consumers or which can be efficiently produced by suppliers • This situation is called a MARKET FAILURE Market Failures

3. Market Failures Market Failures – Video Notes

4. Externality – a cost of benefit to an individual or group that is “external” to the market price (also known as a “spillover” effect) • Negative = • EX: pollution caused by factories producing electrical goods • Positive = • EX: smaller number of cases of the flu due to consumers getting vaccinated Externalities

5. Negative externality: • The market is producing too much of something (i.e. “overproduction” and “overallocation) • The supply curve is too far to the right P Se Sm Pe Pm D Q Qm Qe The Market and Externalities

6. Positive Externality • The market is not producing enough of something (i.e. “underallocation” and “underproduction”) P Sm Pe De Pm Dm Q Qm Qe The Market and Externalities

7. Private goods are: • Excludable = anyone who does not pay for a good can excluded from doing it • Rival in consumption = a good cannot be consumed by more than one person at a time • Public goods are: • Nonexcludable = even those who do not pay for a good can use it • Nonrival in consumption = many people can consume a good without hindering others consumption of the same good Private vs. Public Goods

8. This leads to the free-rider problem • People can use these types of goods without paying for them • Public goods cannot be excluded – therefore there is no efficient way to charge individuals for these types of goods • EX: Streetlights Public Goods and the Free Rider Problem