Market Failures and Externalities

Unit 2: How Markets Work

Market Failures

Sometimes markets are not able to provide the goods and services desired by consumers or which can be efficiently produced by suppliers

This situation is called a MARKET FAILURE

Market Failures – Video Notes

Market Failures

Externalities

Externality – a cost of benefit to an individual or group that is “external” to the market price (also known as a “spillover” effect)

Negative = ◦EX: pollution caused by factories producing

electrical goodsPositive =

◦EX: smaller number of cases of the flu due to consumers getting vaccinated

The Market and Externalities

Negative externality:◦The market is producing too much of something

(i.e. “overproduction” and “overallocation)◦The supply curve is too far to the right

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The Market and Externalities

Positive Externality◦The market is not producing enough of

something (i.e. “underallocation” and “underproduction”)

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Private vs. Public Goods

Private goods are:◦Excludable = anyone who does not pay for a

good can excluded from doing it◦Rival in consumption = a good cannot be

consumed by more than one person at a timePublic goods are:

◦Nonexcludable = even those who do not pay for a good can use it

◦Nonrival in consumption = many people can consume a good without hindering others consumption of the same good

Public Goods and the Free Rider Problem

This leads to the free-rider problem◦People can use these types of goods without

paying for themPublic goods cannot be excluded –

therefore there is no efficient way to charge individuals for these types of goods◦EX: Streetlights