2/21/20101Environmental Market Failure and Policy OptionsA2 EconomicsA recap on market failure•Market failure occurs when the price mechanism fails toMarket failure occurs when the price mechanism fails to deliver an efficient or equitable allocation of resources•Allocative efficiency occurs when the price charged for a product equals the marginal social cost of production•If the market does not price an externality correctly there is a loss of allocative efficiency•This leads to a loss of economic and social welfare and can have severe distributional consequences•Poorer people are often those worse affected by the consequences of climate change
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2/21/20102Allocative inefficiency due to negative externalitiesPriceMarginal private cost (supply)Marginal social cost (supply)Externalities are costs or benefits inflicted upon a third party outside of a market transaction, caused by either under- or over-allocation of resources to aQuantityPrivate Optimal OutputMarginal private benefit (demand)Social Optimal OutputEfficiency Lossresources to a particular product.Lord Stern on Climate Change•“"Climate change is a result of theClimate change is a result of the greatest market failure the world has seen. The evidence on the seriousness of the risks from inaction or delayed action is now overwhelming. We risk damages on a scale larger than the two world wars of the last century. The problem is global and the response must be a collaboration on a global scale."