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Unit 5: Market Failures and Externalities Topic: Govt and Market Failure Chapter: 30.

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Presentation on theme: "Unit 5: Market Failures and Externalities Topic: Govt and Market Failure Chapter: 30."— Presentation transcript:

1 Unit 5: Market Failures and Externalities Topic: Govt and Market Failure Chapter: 30

2 Learning Targets I will be able to explain what externalities are and when they occur, and I can provide several possible solutions to externalities.

3 Public Goods vs. Private Goods Produced by govt Non-rivalry (consumption by one does not mean others cant have it) Non-excludability (no way to stop people from receiving it – free rider problem) Efficiency does not accurately reflect supply and demand. Produced by private firms Rivalry (consumption by one person may mean that others have to do without) Excludable (if you dont pay, you dont get it) Supply, demand and efficiency exist in these markets.

4 Externalities Def: positive and negative spillovers to a third party which were not intended in the original production plan. Can result from production of either public or private goods

5 Terms COSTS Private marginal cost: the actual numerical cost of production to the producer. Social marginal cost: the cost which spills over to society (ex. pollution). Total cost = private marginal cost + social marginal cost BENEFITS Private marginal benefit: the benefit to consumers of the good (measured by utility; consumers pay prices according to utility). Social marginal benefit: the added benefit to society (consumers who dont pay for the good); ex. immunizations. Total benefit = private marginal benefit + social marginal benefit

6 Negative Externalities Occur when: – there are spillover costs (someone other than the producer is paying for the goods production). – social marginal cost is greater than private marginal cost. – marginal cost is greater than marginal benefit. – there is an overallocation of resources to the good (too much of it is being produced).

7 Negative Externality S (private MC) S (social MC) D (private MB) Price/Cost Q Q (market) Q (optimum) Steel Social cost Private cost/price of good

8 What can the govt do for neg. externalities? Govt must discourage production by: Direct controls – laws that regulate the offending activity (ex. pollution prevention technology). Taxes – applied to firms that produce the harmful good (ex. taxing levels of pollution)

9 Positive Externalities Occur when: – there are spillover benefits(someone other than the consumer is gaining from the goods consumption). – social marginal benefit is greater than private marginal benefit. – marginal benefit is greater than marginal cost. – there is an underallocation of resources to the good (too little of it is being produced and consumed).

10 Positive Externality Swine Flu Vaccines S (private MC) D (social MB) D (private MB) Q Price/Cost Q (market) Q (optimum) Social benefit Private benefit/price of good

11 What can govt do for pos. externalities? Govt must encourage production by: 1.Subsidies to consumers – discounts, rebates and coupons (ex. cash for clunkers). 2.Subsidies to sellers – reduces cost that the producer pays ( S will cause lower price for more consumers to be able to pay for it). 3.Provide it as a public good – free for everyone

12 Non-Govt Solutions to Mkt Failures Coase Theorem – If there are clearly-defined property rights and a small number of people involved, problems will work themselves out. Liability rules and lawsuits – Clearly-defined property rights allow courts to rule on externality cases. Market-based approach – Development of a market for externality rights (ex. pollution permits)


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