Chapter 8 Macro - Chapter 8 Market Failure Introduction So...

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Chapter 8 Market Failure Introduction So far we have concluded that markets are efficient; but we made some assumptions about how markets work. If these assumptions do not hold, our conclusion about efficiency may be flawed. What are those assumptions? Market Failure In some markets, few firms may have control over the market price. When firms can control the market price, we say that they have market power. Market power can cause inefficiency because it will lead to higher prices and lower quantities than the competitive solution. Externalities Sometimes the market system fails to produce efficient outcomes because of side effects called externalities . When there are positive externalities , the private market supplies too little of the good in question. When there are negative externalities the market supplies too much. Public Goods Another source of market failure is that competitive markets provide less than the efficient quantity of public goods. A public good is a good or service that someone can consume simultaneously with everyone else even if he or she doesn’t pay for it. Imperfect Information Many economists believe that imperfect information also causes market failures. Asymmetric information is a situation where some people know what other people don’t know. This can lead to adverse selection where an informed party benefits in an exchange by taking advantage of knowing more than other party. 8.1 Externalities Sometimes the market system fails to produce efficient outcomes because of side effects called externalities . Externality : a benefit or cost from consumption or production that spills over onto those who are not consuming or producing the good. 8.1 Externalities Positive externality occurs when benefits spill over to an outside party who is not involved in producing or consuming the good. Negative externality occurs when costs spill over to an outside party who is not involved in producing or consuming the good. Negative Externalities in Production The classic example of a negative externality is the air used by an air-polluting factory. The polluted air “spills over” to outside parties. Such damages are real costs, but, unlike the other resources the firm uses in production, no one owns the air, so the firm does not have to pay for its use.
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Negative Externalities If a firm can avoid paying the cost it imposes on others—the external costs—it lowers its own costs of production, but not the true cost to society. What Can the Government Do to Correct for Negative Externalities? The government can intervene in market decisions in an attempt to take account of negative externalities. If the government could impose a pollution tax equal to the exact size of the external cost, then the firm would produce at the socially desired level of output.
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