1. Market Failure

2. ...is the presence of inefficiency in a market
Market Failure
...is the presence of inefficiency in a market
Type of Efficiency
Efficient when...
Failure when...
Productive efficiency
when ATC is at a minimum
When costs are higher than the minimum
Allocative efficiency
when MC = AR
[or when S = D]
What is produced is what is demanded
When more or less than the true equilibrium is produced
Pareto efficiency
When it is not possible to make anyone better off, without making someone worse off
When either productive or allocative efficiency is missing

3. So what causes Market Failure?
Externalities
- Consumers not paying the true cost
Information Failure
-lack of understanding
Inequality
- Waste of resources
So what causes Market Failure?
Free-riders
– consumers who don’t pay at all
Market Structure – lack of competition
Discrimination
- Inefficient choices

4. Positive and Negative Externalities

5. Positive and Negative Externalities
The effects of a decision by consumers and producers that has an impact on a third party
Negative Externalities – costs incurred by third parties
Positive Externalities – beneficial effects on third parties

6. Negative Externalities
Cost to third parties
(externality) £9
Social Cost
(to the whole of society) £12
Private Cost
(to the consumer) £3

7. Negative Externalities
Costs in production and consumption:
External costs in production – where MSC > MPC (there are external costs)
e.g. air and water pollution, congestion, housing development on green belt areas, destruction of hedgerows and wildlife, noise, pollution…
External costs in consumption – where MPB > MSB (there are external costs)
e.g. passive smoking, litter, noise, anti-social behaviour, binge drinking...

8. If there are externalities present...
...the market is inefficient

9. Why are externalities inefficient?
Negative Externalities– socially efficient output should be less than current output. So true allocative equilibrium in not achieved..too much is produced.
Allocative Efficiency is only achieved where MSC = MSB [true supply = true demand]

10. True Equilibrium – allocative efficiency
The Marginal Social Benefit curve (MSB) represents the sum of the benefits to everyone in society as a whole – the private and external benefits together. This is the true Demand.
The Marginal Social Cost (MSC) curve represents the sum of the costs to everyone in society as a whole – the private and external costs together.
This is the true Supply curve.
Price
MSC=S £5
The slide has been designed to try to lead students through the distinction between the private costs of production and the social cost. The diagram starts out with a basic supply and demand position with price at £5 and Quantity at 100. The demand curve has been labelled MSB – a brief explanation of the concept here is useful. The true supply curve should be the MSC. This is true equilibrium.
MSB=D
100
Quantity Bought and Sold

11. Negative External Costs of Production
The MPC does not take into account the cost to society of production. The producer reaches equilibrium at 130 units of output.
But what is the cost to society of this over production?
Price
MSC=S
MPC £5
Welfare loss caused by externality
The slide has been designed to try to lead students through the distinction between the private costs of production and the social cost. The diagram starts out with a basic supply and demand position with price at £5 and Quantity at 100. The demand curve has been labelled MSB – a brief explanation of the concept here is useful. The supply curve is the marginal private cost – the cost to the producer. To try to link the theory to the practice it is suggested that the item in question is the production of rolls of Clingfilm! The reason is that in producing cellophane products there is an amount of air pollution. If students are told that the cost to the producer of manufacturing 100 rolls of Clingfilm is £5 (don’t forget to remind them that this figure includes the element of profit they make) but, the company do not take into consideration the cost imposed on society of the pollution they cause. This cost is then highlighted by a dashed line moving up from the bottom and is priced at £12 . The supply curve that considers the true cost (the MPC and MSC) is then drawn in and the right brace appears to indicate the extent of the social cost (£7).
The welfare loss triangle is then imposed – this may need to be explained and students could be reminded of the work done on consumer surplus to help reinforce the concept of the ‘value’ here. Finally, the socially efficient output is highlighted; students can be told that there would be benefits to society if less were produced but that we would be paying more as a result!
MSB=D
100
130
Quantity Bought and Sold

12. Negative External Costs of Consumption
The MPB does not take into account the cost to society of consumption. The consumer reaches equilibrium at 140 units of output.
But what is the cost to society of this over consumption?
Price
MSC=S
Welfare loss caused by externality £5
The slide has been designed to try to lead students through the distinction between the private costs of production and the social cost. The diagram starts out with a basic supply and demand position with price at £5 and Quantity at 100. The demand curve has been labelled MSB – a brief explanation of the concept here is useful. The supply curve is the marginal private cost – the cost to the producer. To try to link the theory to the practice it is suggested that the item in question is the production of rolls of Clingfilm! The reason is that in producing cellophane products there is an amount of air pollution. If students are told that the cost to the producer of manufacturing 100 rolls of Clingfilm is £5 (don’t forget to remind them that this figure includes the element of profit they make) but, the company do not take into consideration the cost imposed on society of the pollution they cause. This cost is then highlighted by a dashed line moving up from the bottom and is priced at £12 . The supply curve that considers the true cost (the MPC and MSC) is then drawn in and the right brace appears to indicate the extent of the social cost (£7).
The welfare loss triangle is then imposed – this may need to be explained and students could be reminded of the work done on consumer surplus to help reinforce the concept of the ‘value’ here. Finally, the socially efficient output is highlighted; students can be told that there would be benefits to society if less were produced but that we would be paying more as a result!
MPB
MSB=D
100
140
Quantity Bought and Sold

13. Positive Externalities
Benefit to third parties
(externality) £10
Social Benefit
(to the whole of society) £15
Private Benefit
(to the consumer) £5

14. Positive Externalities
Benefits in production and consumption:
External benefit in production
where MPC > MSC (there are external benefits)
e.g. human resource development, research and development in industry, pleasant looking buildings, clean water…
External benefits in consumption
– where MSB > MPB (there are external benefits) e.g. preventative health care – vaccinations, public transport, attractive private gardens, bathing regularly, pretty balloons in the sky...

15. If there are externalities present...
...the market is inefficient

16. Why are externalities inefficient?
Positive Externalities– socially efficient output would be greater than current output. So true allocative equilibrium is not achieved...too little is produced.
Allocative Efficiency is only achieved where MSC = MSB [true supply = true demand]

17. True Equilibrium – allocative efficiency
The Marginal Social Benefit curve (MSB) represents the sum of the benefits to everyone in society as a whole – the private and external benefits together. This is the true Demand.
The Marginal Social Cost (MSC) curve represents the sum of the costs to everyone in society as a whole – the private and external costs together.
This is the true Supply curve.
Price
MSC=S £5
The slide has been designed to try to lead students through the distinction between the private costs of production and the social cost. The diagram starts out with a basic supply and demand position with price at £5 and Quantity at 100. The demand curve has been labelled MSB – a brief explanation of the concept here is useful. The true supply curve should be the MSC. This is true equilibrium.
MSB=D
100
Quantity Bought and Sold

18. Positive External Benefits of Production
The MPC does not take into account the benefits to society of production. The producer reaches equilibrium at only 80 units of output.
But what is the cost to society of this under production?
MPC
Price
MSC=S £5
Welfare loss caused by externality
The slide has been designed to try to lead students through the distinction between the private costs of production and the social cost. The diagram starts out with a basic supply and demand position with price at £5 and Quantity at 100. The demand curve has been labelled MSB – a brief explanation of the concept here is useful. The supply curve is the marginal private cost – the cost to the producer. To try to link the theory to the practice it is suggested that the item in question is the production of rolls of Clingfilm! The reason is that in producing cellophane products there is an amount of air pollution. If students are told that the cost to the producer of manufacturing 100 rolls of Clingfilm is £5 (don’t forget to remind them that this figure includes the element of profit they make) but, the company do not take into consideration the cost imposed on society of the pollution they cause. This cost is then highlighted by a dashed line moving up from the bottom and is priced at £12 . The supply curve that considers the true cost (the MPC and MSC) is then drawn in and the right brace appears to indicate the extent of the social cost (£7).
The welfare loss triangle is then imposed – this may need to be explained and students could be reminded of the work done on consumer surplus to help reinforce the concept of the ‘value’ here. Finally, the socially efficient output is highlighted; students can be told that there would be benefits to society if less were produced but that we would be paying more as a result!
MSB=D 80
100
Quantity Bought and Sold

19. Positive External Benefits of Consumption
The MPB does not take into account the benefit to society of consumption. The consumer reaches equilibrium at 90 units of output.
But what is the cost to society of this under consumption?
Price
MSC=S
Welfare loss caused by externality £5
The slide has been designed to try to lead students through the distinction between the private costs of production and the social cost. The diagram starts out with a basic supply and demand position with price at £5 and Quantity at 100. The demand curve has been labelled MSB – a brief explanation of the concept here is useful. The supply curve is the marginal private cost – the cost to the producer. To try to link the theory to the practice it is suggested that the item in question is the production of rolls of Clingfilm! The reason is that in producing cellophane products there is an amount of air pollution. If students are told that the cost to the producer of manufacturing 100 rolls of Clingfilm is £5 (don’t forget to remind them that this figure includes the element of profit they make) but, the company do not take into consideration the cost imposed on society of the pollution they cause. This cost is then highlighted by a dashed line moving up from the bottom and is priced at £12 . The supply curve that considers the true cost (the MPC and MSC) is then drawn in and the right brace appears to indicate the extent of the social cost (£7).
The welfare loss triangle is then imposed – this may need to be explained and students could be reminded of the work done on consumer surplus to help reinforce the concept of the ‘value’ here. Finally, the socially efficient output is highlighted; students can be told that there would be benefits to society if less were produced but that we would be paying more as a result!
MPB
MSB=D 90
100
Quantity Bought and Sold

20. Quick Diagram Test MSC=S MPC MPC MSC=S Negative Production Externality
Positive Production Externality
MSB=D
MSB = D
“Deforestation”
“Water purification during production”
MSC=S
MPB
MSC=S
Negative Consumption Externality
MSB=D
MPB
Positive Consumption Externality
MSB=D
“Litter”
“Christmas house lights”

21. Quick Diagram Test Where’s the Welfare Loss?
MSC=S
MPC
MPC
MSC=S
MSB=D
MSB = D
Negative Production Externality
Positive Production Externality
MSC=S
MPB
MSC=S
MSB=D
MPB
MSB=D
Negative Consumption Externality
Positive Consumption Externality