Chapter 4. Market Failures: Public Goods and Externalities

Chapter 4Market Failures: Public Goods and ExternalitiesCopyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Market FailuresMarket failures Markets fail to produce the right amount of the productResources may beOver-allocatedUnder-allocatedLO1Demand-Side Market FailuresDemand-side market failuresWhen it is not possible to charge consumers for the productSome can enjoy benefits without payingFirms not willing to produce since they cannot cover the costsLO1Supply-Side Market FailuresSupply-side market failuresOccurs when a firm does not pay the full cost of producing its outputExternal costs of producing the good are not reflected in supplyLO1Efficiently Functioning MarketsDemand curves must reflect the consumers full willingness to paySupply curve must reflect all the costs of productionLO2Consumer SurplusConsumer surplusDifference between what a consumer is willing to pay for a good and what the consumer actually paysExtra benefit from paying less than the maximum priceLO2Producer SurplusProducer surplusDifference between the actual price a producer receives and the minimum price they would acceptExtra benefit from receiving a higher priceLO2Efficiency RevisitedLO2SQ1P1DConsumer surplusProducer surplusEfficiency LossesEfficiency loss (or deadweight losses)LO2Quantity (bags)Price (per bag)cSQ1Q2DbdaeEfficiency lossfrom underproductionEfficiency LossesLO2cSQ1Q3DbfagQuantity (bags)Price (per bag)Efficiency lossfrom overproduction Private GoodsPrivate goods are produced in the market by firmsOffered for saleCharacteristicsRivalryExcludabilityLO3Public GoodsPublic goods are provided by governmentOffered for freeCharacteristicsNonrivalryNonexcludabilityFree-rider problemLO3Cost-Benefit AnalysisCost-benefit analysisCostResources diverted from private good productionPrivate goods that will not be producedBenefitThe extra satisfaction from the output of more public goodsLO4Quasi-Public GoodsQuasi-public goods could be provided through the market systemBecause of positive externalities the government provides themExamples are education, streets, museumsLO4The Reallocation ProcessGovernmentTaxes individuals and businessesTakes the money and spends on production of public goodsLO4ExternalitiesAn externality is a cost or benefit accruing to a third party external to the market transactionPositive externalitiesToo little is producedDemand-side market failuresNegative externalitiesToo much is producedSupply-side market failuresLO4ExternalitiesLO4(a)Negative externalities(b)Positive externalities0DSStOverallocationNegativeexternalitiesStUnderallocationPositiveexternalitiesQoQoQeQePP0QQDDtaczxbyGovernment InterventionCorrect negative externalitiesDirect controlsSpecific taxesCorrect positive externalitiesSubsidiesGovernment provisionLO4Government’s Role in the EconomyCoase theoremPrivate sector bargaining can solve externality problemGovernment’s role in correcting externalitiesOptimal reduction of an externalityOfficials must correctly identify the existence and causeHas to be done within a political environmentLO5