Chapter 05: Market Failures: Public Goods and Externalities

Market Failures Market fails to produce the right amount of the product Resources may be Over-allocated Under-allocated

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Market Failures: Public Goods and Externalities05McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.Market FailuresMarket fails to produce the right amount of the productResources may beOver-allocatedUnder-allocatedLO15-*Demand-Side FailuresImpossible to charge consumers what they are willing to pay for the productSome can enjoy benefits without payingLO15-*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 supplyLO15-*Efficiently Functioning MarketsDemand curve must reflect the consumers full willingness to paySupply curve must reflect all the costs of productionLO15-*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 priceLO25-*Consumer SurplusLO2LO2DQ1P1Consumer SurplusEquilibrium Price5-*Producer SurplusDifference between the actual price a producer receives and the minimum price they would acceptExtra benefit from receiving a higher priceLO25-*Producer SurplusLO2LO2SQ1P1Equilibrium priceProducer surplus5-*Efficiency RevisitedLO2SQ1P1DConsumer surplusProducer surplus5-*Quantity (bags)Price (per bag)Efficiency LossesLO2cSQ1Q2DbdaeEfficiency lossfrom underproduction5-*Efficiency LossesLO2cSQ1Q3DbfagQuantity (bags)Price (per bag)Efficiency lossfrom overproduction 5-*Private GoodsProduced in the market by firmsOffered for saleCharacteristicsRivalryExcludabilityLO35-*Public GoodsProvided by governmentOffered for freeCharacteristicsNonrivalryNonexcludabilityFree-rider problemLO35-*Cost-Benefit AnalysisCost Resources diverted from private good productionPrivate goods that will not be producedBenefitThe extra satisfaction from the output of more public goodsLO35-*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 failuresLO45-*Government InterventionCorrect negative externalitiesDirect controlsSpecific taxesCorrect positive externalitiesSubsidies Government provisionLO45-*Government InterventionLO4(a)Negative externalitiesDSStOverallocationNegativeexternalitiesQoQeP0Qacb(b)Correct externality with taxDSStQoQeP0QaT5-*Government InterventionLO4Methods 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 provision5-*Government’s 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 politicsLO55-*
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