Market Failure - Market Failure, Externalities, External Costs, Private Costs, Social Costs, External Benefits, Private Benefits and Social Benefits

What is market failure?

Market failure occurs when the price mechanism causes an inefficient allocation of resources; the forces of demand and supply lead to a new welfare loss in society. Consequently, resources are not allocated to their best or optimum use.

Explain the social optimum equilibrium

The social optimum equilibrium level of output or price for a good or service occurs where the Marginal Social costs (MSC) equals marginal social benefit (MSB). The social cost of producing the last unit of output equals the social benefit from consuming it. When the social optimum is reached in a market, welfare is maximised.

Explain the free-market equilibrium

The supply curve for a firm is the Marginal Private Cost curve (MPC). The addition of all the MPC curves of firms in a market for a particular good or service will form the market supply curve. The demand curve for consumers in the Marginal Private Benefit (MPB). Economoists assume that it is possible to measure the benefit obtained from consuming a good by the price people are prepared to pay for it. As an individual consumes more units of a good, the marginal benefit (marginal utility) will fall. This is why the demand curve slopes downwards from left to right. Market equilibrium occurs where MPB equal MPC.

What is the triangle welfare gain?

The welfare gain triangle on a externality diagram that depicts the excess of social benefits over social costs for a given output level

What is the triangle welfare loss?

The welfare loss triangle is the area on the externality diagram that depicts the excess of social costs over social benefits for a given level output

What are the types of market failures we focus on?

- Externalities - Public goods - Imperfect market information - Labour immobility - Unstable commodity markets

What are Social Benefits?

By adding private benefits to external benefits we obtain social benefits. This means external benefits are the difference between private benefits and social benefits. The marginal private benefit and marginal social benefit curve often diverge, indicating that external benefits increase disproportionately with output consumed (At a negative gradient) . However, it is possible that external benefit per unit consumed will remain constant, in which case the marginal private benefit and marginal social benefit curves are drawn parallel to each other.

What are Social Costs?

By adding private costs to external costs we obtain social costs. This means that external costs are the difference betweenprivate costs and social costs. The marginal private cost and marginal social cost curves often diverge, indicating that external costs increase disproportionately with output (At a positive gradient). However it is possible that external costs per unit of output remain constant, in which case the marginal private cost and marginal social costs curves are drawn parallel to each other.

What are External benefits?

External benefits may occur in the production and consumption of a good or service. An example of an external benefit in production is recycling of waste materials such as glass, tins etc. It has the benefit of reducing the amount of waste disposal for landfill sites as well as re-using materials for production. It helps to promote sustainable economic growth. An external benefit in consumption is the vaccination of an individual against various diseases. It reduces the possibility of other people catching a disease who come into contact with the vaccinated individual.

What are external costs?

External costs may occur in the production and the consumption of a good or service. An example of an external cost in production is a chemical firm polluting a river with its waste. This causes an external cost to the fishing and water supply industries. Fish catches may be reduced and it may become very expensive to purify water to meet European Commission's safety standards. An example of an external cost in consumption is a person smoking tobacco, polluting the air for others. The effect is to cause passive smoking, where non-smokers may suffer the same illnesses as smokers.

What are Externalities?

Externalities are also known as indirect costs and benefits which are external to an exchange. They are third party effects ignored by the price mechanism. Externalities are also known as indirect costs and benefits, or as spillovers from production or consumption of a good or service. In effect, external costs are negative externalities and external benefits are positive externalities.

What are Private Benefits?

In a free market, consumers are only concerned with the private benefits or utility from consuming a good or service. Economists assume that this can be measured by the price that consumers are prepared to pay for a good or service. Private benefits may also refer to the revenue that a firm obtains from selling a good or service.

What is a private cost?

In a free market, producers are only concered with the private costs of production. These are costs internal to the firm, which it directly pays for. These costs include wages for workers, rent of buildings, payment for raw materials, machinery costs, electricity and gas costs, insurance, packaging and transport costs from running lorries fro example. Private costs may also refer to the market price that a consumer pay for a good or service.