A.P. Microeconomics Warm Up: for each of the following scenarios identify and explain briefly which market failure is being described: An auto repair shop convinces you that you need a $2,000 valve job, when all you really need is an oil change. Everyone in the neighborhood would benefit if an empty lot were turned into a park, but no entrepreneur will come forward to finance the transformation. Someone who lives in an apartment building buys a Wayne Newton album and blasts it until 3am each night. The only two airlines flying directly from Buffalo to Albany make an agreement to raise their prices.

Market Failures In a competitive market, the firms and the households determine the supply and demand of inputs and outputs; in other words, they determine the price and quantity of all. However when the market cannot determine the terms of exchange – price, quantity, location, service, financing, etc. – and/or one party is not willing or able to pay the price, the market fails. Thus there is a need and function for ____________________________. Government

Results of Externalities A cost or benefit resulting from some activity or transaction that is imposed or bestowed on parties not involved with the activity/transaction Pollution is the classic example, but there are many others: noise, congestion, distaste

Results of Externalities Ex) an economically successful business in production pollutes the land by seeping chemicals into the local water supply. Who Pays the Price? What should government do?

Social Costs Since externalities are those costs not incurred by the buyer or the seller of a market transaction (the costs are incurred by the public), then social costs are equal to private costs and the value of the externalities. (SC = MC + externality) Thus we can distinguish marginal private costs (MPC or MC) from marginal social costs knowing the MSC > MC (private) since marginal social costs incorporate marginal private costs. These distinctions will serve us well when we discuss the government, taxes and subsidies.

Social Costs Tax Subsidize For example, social costs will equal private costs when government either ___________________ negative externalities or _________________________ positive externalities by the amounts of the externalities. In this way, the government hopes to move the markets to some level of efficiency to compensate for market failure. Tax Subsidize

Social Costs What is a tax? Government charge on households & firms What is a subsidy? Government charge on households & firms Government payment to households & firms

Need for Government Market failure also refers to failure of the market mechanisms to achieve optimal or efficient outcomes. An efficient social outcome would be when _____________________________ (MSB) equals _________________________ (MSC). Therefore, market failure to produce efficient outcomes becomes a general basis for government intervention. A complete market failure to find MSB = MSC for certain goods is the case for a public good. For Example: Marginal Social Benefit Marginal Social Cost

Group Activity Identify Market Failure & Explain It Recreate the 4 square for your groups market failure. NO notes!!! Monopoly Public Good Imperfect Information Externality If I choose your group’s poster to hang up, you will be exempt from the Chap 11 outline!! This will be graded and added to your homework grade!! Identify Market Failure & Explain It Illustration of Term List at least 3 examples of when this happens Answer Question: How does government help to correct this market failure?