Notesale: Turn your study into money

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● Externalities, the under-provision of public goods and information gaps are all
types of market failure
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g
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● Partial market failure occurs when the private sector may provide the good or
service, but at the wrong price or quantity (e
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private healthcare vs NHS)
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● External costs = negative third party effects outside of a transaction (e
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passive smoking)
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● External costs = negative externalities
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● Social costs = external costs + private costs
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g
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● Private benefits = benefits that are internal to a transaction, so affect me or
the firm (taken into account by the price mechanism) - utility from consuming
a good or service OR revenue
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● By ignoring the external costs of production and consumption, this can lead
to: overproduction, underpricing, welfare loss and environmental issues
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g
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● Market equilibrium = where marginal private benefit equals marginal private
cost
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Solutions to market failure = education, taxes, legislation or making it free
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● Marginal private cost (MPC) is drawn as a “supply curve” (but don’t say that
in the exam)
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This graph (above) shows the difference between MSC and MPC
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It shows that from Q 1 to Q2 there is an
overconsumption of cars
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The vertical line AB represents the value of the external cost
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The blue triangle forms
the welfare gain to society
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This can only be
corrected by government
intervention
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We only need
to know the positive
externalities of consumption
graph
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Examples

External costs

External benefits

Production

Plastic bottles getting
dumped out at sea,
burning coal adds to
global warming and
increased production of
chairs leads to more
deforestation and habitat
destruction
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Consumption

Excess alcohol intake can
lead to more crime and
violence, if Heathrow
airport expands then
there will be more traffic
on the roads surrounding
it and smoking tobacco
near children can harm
their development
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Public goods
● Pure public goods = goods that have non-rivalry and non-excludability in
their consumption
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➔ As more people consume a good, it does not reduce the amount
available for others (non-rivalry)
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● There are also quasi public goods which have some of the traits of pure
public goods, but not all - e
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they might have non-excludability but have
rivalry, like police protection or healthcare
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The free-rider problem
● In a free-market economy, public goods are underprovided because once a
public good has been provided for 1 individual, you cannot exclude others
from reaping the benefits of it
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● Firms are reluctant to supply public goods, as they are difficult to gain profits
from
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● Therefore people will get the benefits of a good or service without incurring a
cost from it
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● Missing market = associated with the difficulties the free market has in
providing pure public goods, meaning that they are simply not provided
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● Non-excludability = when benefits derived from pure public goods cannot be
confined to those who have paid for it, giving rise to the free rider problem
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● Imperfect information can lead to an overconsumption of demerit goods and
an underconsumption of merit goods (because people are not aware of their
costs/benefits)
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● Asymmetric information = where consumers and producers have unequal
access to information about a good or service in the market (e
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“lemon
markets” emerge, such as in the market for used cars where producers have
more knowledge about their condition than consumers)
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