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Principles of Economics- Mankiw (5th) 198

Principles of Economics- Mankiw (5th) 198 - 206 PA R T F O...

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206 PART FOUR THE ECONOMICS OF THE PUBLIC SECTOR Markets do many things well, but they do not do everything well. In this chap- ter we begin our study of another of the Ten Principles of Economics: Governments can sometimes improve market outcomes. We examine why markets sometimes fail to allocate resources efficiently, how government policies can potentially im- prove the market’s allocation, and what kinds of policies are likely to work best. The market failures examined in this chapter fall under a general category called externalities. An externality arises when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect. If the impact on the bystander is adverse, it is called a negative externality; if it is beneficial, it is called a positive externality. In the pres- ence of externalities, society’s interest in a market outcome extends beyond the
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