Market Failure
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Occurs when the market is not able to allocate resource efficiently
Externalities
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Occurs when the actions of consumers and producer give rise to negative or positive side-effect on people who are not part of these actions
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Allocative efficiency and social optimum is achieved when MSC = MSB (MSC = MPC = MSB = MPB)
Conditions
Goods you must know
Negative Production Externality
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External costs created by producers
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Example: Factories that polluted to the environment
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The intersection of MPC and MPB determines the free market outcome price Pm and quantity Qm
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The intersection of MSC and MSB determines the social optimum level of output price Popt and quantity Qopt
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The vertical difference between MSC and MPC represents the external cost for the society.
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Qm > Qopt indicates an overallocation of resources
Welfare loss of negative production externality
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Welfare loss = difference between MSC and MSB for the amount of output that is overproduced (Qm - Qopt)
Correcting negative production externalities
*Goal of the government
*(using productions that including emission as an example)
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Externals costs created by consumer
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Example: Consumer smoke in the public place, the external cost will be the second hand smoke
Negative Consumption Externalities
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The intersection of MPC and MPB determines the free market outcome price Pm and quantity Qm
-
The intersection of MSC and MSB determines the social optimum level of output price Popt and quantity Qopt
-
The vertical difference between MSB and MPB represents the external cost for the society.
-
Qm > Qopt indicates an overallocation of resources
Welfare loss of negative consumption externalities
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Welfare loss = The difference between the MSC and MSB curves for the amount of output that is overproduced relative to the social optimum (Qm - Qopt).
Correcting negative consumption externalities
*Goal of the government
Positive Externalities of production
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External benefits created by producers
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Example: Training programme produced by firm for the workers that could bring further benefits to the society by producing more beneficial good using trained knowledge
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The intersection of MPC and MPB determines the free market outcome price Pm and quantity Qm
-
The intersection of MSC and MSB determines the social optimum level of output price Popt and quantity Qopt
-
The vertical difference between MPC and MSC represents the external benefits for the society.
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Qm < Qopt indicates an underallocation of resources
Welfare loss of positive externalities of production
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Welfare loss = The difference between the MSB and MSC curves for the amount of output that is underproduced relative to the social optimum (Qopt - Qm)
Correcting positive externalities of production
*Goal of the government
Positive consumption externalities
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External Benefits created by consumers
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Example: Education that will not only give people knowledge, but also the external benefits such as more productive labour, more friendly society...etc
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The intersection of MPC and MPB determines the free market outcome price Pm and quantity Qm
-
The intersection of MSC and MSB determines the social optimum level of output price Popt and quantity Qopt
-
The vertical difference between MPB and MSC represents the external benefits for the society.
-
Qm < Qopt indicates an underallocation of resources
Welfare loss of positive consumption externalities
-
Welfare loss = The difference between the MSB and MSC curves for the amount of output that are underproduced relative to the social optimum (Qopt - Qm)
Correcting positive consumption externalities
*Goal of the government
