Market Failure

1. Market Failure • Market prices usually reflect the benefits and costs received by the producers and consumers involved in an exchange. • A kind of market failure occurs when market prices DO NOT reflect all the costs and all the benefits involved. • This type of market failure is calledan externality.

2. Externalities • Externalities exist when some of the costs or benefits associated with the production or consumption of a product "spill over" to third parties, who do not produce or pay to consume the product. • Negative externalities are costs paid by someone who does not produce or pay to consume a product. • Examples? Cigarette smoking: secondhand smoke; health costs

3. Externalities • Positive externalities are benefits enjoyed by someone who does not produce or pay to consume a product. • Examples? Education: society benefits from increased productivity; less crime; lower rates of poverty; etc.

4. Positive or Negative Externalities • Driving a car on crowded highway? • Negative: exhaust fumes, etc. • Apartment dwellers who buy fire alarms or fire extinguishers? • Positive: other dwellers benefit • Neighbor playing loud music while you study? • Negative: you bear cost of not concentrating • New landscaping in neighbor’s yard? • Positive: increases value of houses in neighborhood.

5. Activity 12.2: Externalities Worksheet S1 Price S P1 P D 0 Quantity (Tons of Steel) Q1 Q

6. Activity 12.2: Externalities Worksheet Price S P1 P D1 D 0 Q Q1 Quantity (Years of Education)