Chapter 16--Market Failure...Externalities, Public Goods, and Asymmetric Information

Chapter 16--Market Failure...Externalities, Public Goods, and Asymmetric Information

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Chapter 16—Market Failure: Externalities, Public Goods, and Asymmetric Information I. Externalities A. An externality is a side effect of an action that affects the well-being of third parties. There are two types of externalities: negative and positive. 1. A negative externality exists when an individual’s or group’s actions cause a cost (adverse side effect) to be felt by others. 2. A positive externality exists when an individual’s or group’s actions cause a benefit (beneficial side effect) to be felt by others. B. When either negative or positive externalities exist, the market output is different from the socially optimal output. 1. In the case of a negative externality, the market is said to overproduce the good connected with the negative externality (the socially optimal output is less than the market output). 2. In the case of a positive externality, the market is said to underproduce the good connected with the positive externality (the socially optimal output is greater than the
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