ExternalitiesMarket Failures: When the Market Fails

Market Failures

Examples of Market Failures• Collusion• Price fixing• Predatory pricing• Externalities

Occur when the market fails to allocate resources efficiently

Price

Qty

D1D1

S1S1

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Q1

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Q1

E1P1 --------------P1 --------------

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Without a market failure, when S = D, Social Welfare is maximized

Reading #1

Externalities

Reading #1: Externalities

Negative ExternalityNegative Externality?

EXTERNALITY Summary

• An externality is the uncompensated impact of a person/business on another person/society– Both positive & negative externalities exist

– All externalities are market failures

• Spillover Costs- costs that fall on society– Occur with negative externalities

– Cause production to be too high

• Spillover Benefits- benefits that fall on society– Occur with positive externalities

– Cause production to be too low

Factory A Factory B

Negative Externalities

– Automobile exhaust– Cigarette smoking

– Barking dogs (loud pets)

– Loud stereos in apartments– Noisy Students– Neighbor’s poorly maintained

property

– Pollution

Positive Externalities – Immunizations– Restored historic buildings– Research into new technologies– Neighbor’s well maintained property– Volunteer work

Correcting Externalities

• Government action can correct a market failure– Taxes & subsidies are the primary tools

• Negative externalities lead markets to overproduce

– correct by Gov’t taxing externality

• Positive externalities lead markets to under-produce

– correct by Gov’t subsidizing externality

Correcting a negative externality

Price

Qty

D1D1

S1S1

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Q1

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Q1

E1P1 --------------P1 --------------

Soda Can Production

Assume Soda Can production causes pollution

• Tax Soda cans the amount of spillover cost• Supply shifts left• New equilibrium is socially efficient• Price rises & quantity produced falls

E2

S2

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P2

Q2

Externality Questions

Externality Review

Private Costs gas, insurance, repair

Social Costs (spillover cost)

pollution, traffic, noise

Bottled WaterWhat is the real cost?

Start 20 minutes in…

Documentary

Only 11 states have recycle depositsOnly 20% of U.S. bottles are recycled

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Negative Externality: Global Warming:

• Government Regulation– raise pollution standards globally

– Critical thinking: Should countries all have the same standards?

• Free Market Solution: Cap & Trade – Government creates a system of trading pollution credits

– Provides incentive to not pollute