NOTE_Lecture_16_-_Other_types_of_mkt_fai

NOTE_Lecture_16_-_Other_types_of_mkt_fai - Other Kinds of...

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1 Other Kinds of Market failure Review definition of market failure Imperfectly competitive markets – Monopoly, monopolistic competition, oligopoly Externalities – Definition and examples – Graphing and impacts of externalities (rationale for government involvement in the markets) Public goods – Definition and examples – Graphing and impacts of externalities (rationale for government involvement in the markets) Objectives Market failure Definition of market failure: Market failure occurs when the market fails to lead to the socially optimal outcome (in terms of efficiency) Monopoly, monopolistic competition, and oligopoly markets are all examples of market failure (and of imperfect competition) because social welfare (= consumer surplus + producer surplus) is not maximized
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2 Other types of market failure Externalities Public goods Externalities Definition: An externality exists when the actions or decisions of one person or firm imposes a cost (or bestows a benefit) on a third party. Externalities are sometimes referred to as spillover or neighborhood effects. – Negative externality : where the action/decision of a firm or individual has negative impacts on others not involved in the action or decision – Positive externality : where the action/decision of a firm or individual has positive impacts on others not involved in the action or decision Pollution: Negative Externality Pollution is a classic example of a negative externality ¸ where the actions of a firm have negative impacts on others in society
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3 Example: Consider a laundry business that uses toxic chemicals to clean laundry from hotels in San Jose. The costs associated with the cleaning are represented by a marginal cost (MC) curve, and the price received for cleaning laundry is given by the market S and D Pollution: Negative Externality P P Q Q Pp Qp MC D S Suppose, however, that this laundry business dumps the toxic chemicals in the back of its plant. Some of the chemicals find their way to the water table, where we draw our water supply, and some of the chemicals eventually ends up in the Bay. As a result, some people in the society may suffer from side effects from consuming the contaminated water (birth defects for example), while the birds, fish and other animals (and plants) that live in or near the Bay, or rely on the Bay for food, are poisoned and our ecosystem is put under serious stress. Clearly, in this scenario, the costs to society of the laundry business is much more than simply the marginal cost faced by the laundry business itself. That is: P Q Pp Q private MC = PMC SMC Q social Then, the social marginal cost exceeds the private marginal cost, and the “true” MC curve to society is in fact at SMC (> MC = PMC). Thus, the socially optimal quantity that should be produced would be
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NOTE_Lecture_16_-_Other_types_of_mkt_fai - Other Kinds of...

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