Market Failure
Market Failure
Market failure occurs when the market system is unable to achieve an efficient allocation of resources
Positive Externalities
Definition of Positive Externality.
This occurs when the consumption or production of a good causes a benefit to a third party.
•For example, when you consume education you get a private benefit. But there are also benefits to the rest of society. E.g you are able to educate other people and therefore they benefit as a result of your education.
A farmer who grows apple trees, provides a benefit to a beekeeper. The beekeeper gets a good source of nectar to help make more honey.
Therefore with positive externalities the benefit to society is greater than your personal benefit.
Therefore with a positive externality the Social Benefit > Private Benefit
• Remember Social Benefit = private benefit + external benefit.
Diagram of Positive Externality
• In a free market consumption will be at Q1 because Demand = Supply (private benefit = private cost )
• However this is socially inefficient because Social Cost < Social Benefit. Therefore there is under consumption of the positive externality
• Social Efficiency would occur at Q2 where Social Cost = Social Benefit
For example In the real world without govt intervention there would be too little education and public transport.
Negative Externalities • Negative externalities occur when the consumption or production of a good causes a harmful effect to a third party.
• For Example, if you play loud music at night your neighbour may not be able to sleep.
• If you produce chemicals, but cause pollution, then local fishermen will not be able to catch fish. This loss of income will be the negative externality.
• Therefore with a negative externality Social Cost > Private Cost
Diagram of Negative Externality with Deadweight welfare loss • In a free Market people ignore the external costs to others therefore output will be at Q1 (where Demand = Supply).
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Market failure occurs when the market system is unable to achieve an efficient allocation of resources
Positive Externalities
Definition of Positive Externality.
This occurs when the consumption or production of a good causes a benefit to a third party.
•For example, when you consume education you get a private benefit. But there are also benefits to the rest of society. E.g you are able to educate other people and therefore they benefit as a result of your education.
A farmer who grows apple trees, provides a benefit to a beekeeper. The beekeeper gets a good source of nectar to help make more honey.
Therefore with positive externalities the benefit to society is greater than your personal benefit.
Therefore with a positive externality the Social Benefit > Private Benefit
• Remember Social Benefit = private benefit + external benefit.
Diagram of Positive Externality
• In a free market consumption will be at Q1 because Demand = Supply (private benefit = private cost )
• However this is socially inefficient because Social Cost < Social Benefit. Therefore there is under consumption of the positive externality
• Social Efficiency would occur at Q2 where Social Cost = Social Benefit
For example In the real world without govt intervention there would be too little education and public transport.
Negative Externalities • Negative externalities occur when the consumption or production of a good causes a harmful effect to a third party.
• For Example, if you play loud music at night your neighbour may not be able to sleep.
• If you produce chemicals, but cause pollution, then local fishermen will not be able to catch fish. This loss of income will be the negative externality.
• Therefore with a negative externality Social Cost > Private Cost
Diagram of Negative Externality with Deadweight welfare loss • In a free Market people ignore the external costs to others therefore output will be at Q1 (where Demand = Supply).
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