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Unformatted text preview: 1 13. Externalities, common resources and public goods Sources of market failure Market failure is a condition that occurs when the unrestrained operation of a market yields economically inefficient results. Main areas of market failure are Public goods Externalities Common resources Asymmetric information. Market failure produces deadweight loss. Market failure and deadweight loss A positive externality exists when there are uncompensated benefits that are received by individuals who are not directly involved in the production or consumption of goods. A negative externality exists when there are uncompensated costs that are imposed upon individuals who are not directly involved in the production or consumption of goods. Definition of externalities Social marginal costs and benefits social marginal cost : the sum of private marginal cost and the external cost of production or consumption social marginal benefit : the sum of the private marginal benefit and the external benefit of production or consumption. Externalities and market inefficiency Negative externalities lead to market failure. When there are negative externalities in either production or consumption, markets produce larger quantities than are socially desirable. The social costs are greater than the private costs to producers and consumers. OR, the social value is less than the private value to producers and consumers. 2 How external costs affect resource allocation Price ($/tonne) Quantity (tonnes/year) Price ($/tonne) D D Private MC 12 000 1300 S = MC 12 000 1300 Private equilibrium Quantity (tonnes/year) 2000 8000 Social optimum 2300 XC = $1000/tonne Social MC = Private MC + XC Production without external cost Production with external cost Externalities and market inefficiency Positive externalities in production or consumption lead to market failure. When there are positive externalities in either production or consumption, the market produces a smaller quantity than is socially desirable. The social costs are less than the private cost to producers and consumers. OR, the social value is greater than the private value to producers and consumers. A good whose production generates a positive externality for consumers Price Quantity D = MB S=MC Q pvt MB PVT Without external benefits Q PVT is the social optimum Social MB = MB + XB XB MB SOC MB PVT + XB Q SOC With external benefits the private D < social D and the private optimum is less than the social optimum 4 possibilities, 4 deadweight losses Overhead Attainment of the optimal output Internalising an externality involves altering incentives so that people take into account the external effects of their actions....
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