1. Market Failure

2. Content Externalities in Production and Consumption: Public goods
Positive
Negative
Public goods
Merit goods
Demerit goods
Market imperfections
Inequalities in:
Wealth distribution
Income distribution

3. Externalities
Externalities result from differences between private and social costs or benefits
Externalities can be positive or negative:
Positive – these have beneficial effects on 3rd parties
Negative – these are costs that incurred by 3rd parties

4. External Costs / Negative externalities
External costs created by businesses can impact the environment in the following ways:
Urban blight – excessive development and inappropriate developments mean the environment is visually less attractive, loss of farmland
Production and disposal of waste – this could include an increase in litter and rubbish from packaging
Use of energy
Pollution:
Noise – from cars, lorries, factories etc
Air – emissions from cars and delivery vehicles
Land
Sea
Water

5. Negative externalities
If you consider private costs then they would supply along supply curve S
Negative externalities mean that social costs are higher so the new supply curve should be S1 and equilibrium moved to P1

6. External Benefits / Positive externalities
As well as external costs businesses can create external benefits
External benefits are advantages a business brings to the local community when it locates its business in a particular area. These benefits will be positive for the local community.
Examples:
Employment
Quality of life
Providing a service
Regeneration of land

7. External Benefits / Positive Externalities
If the business was supplying products ignoring social benefits the initial supply curve S1

8. External Costs and benefits In production
External costs are where MSC = MSB – MPC e.g. pollution, traffic congestion
External benefits are where MSC < MPC e.g. research and development in industry, human resource development

9. External costs and benefits in consumption
External costs = where MSB < MPB e.g. anti-social behaviour, passive smoking, noise
External benefits = where MSB > MPB e.g. public transport, vaccinations, attractive surroundings

10. Externalities
The presence of negative externalities is likely to cause over production of a product
The presence of positive externalities is likely to lead to under production of a product
Externalities can lead to market failure if the pricing mechanism fails to account for the social costs and benefits of production

11. Value of Externalities
The value of social costs and benefits can be measured by looking at:
Consumer surplus
Producer surplus
Cost-benefit analysis : what is the balance of costs and benefits
Willingness to pay

12. Cost Benefit Analysis Identify all costs and benefits
Measure the value of all costs and benefits
Calculate the likelihood of costs and benefits
Analyse the timing of the costs and benefits looking at present value
Decide whether the project is worth undertaking

13. Public Goods These are services that are provided by the government
Pure public goods have the following characteristics:
Non excludability – everyone can consume the goods whether they pay or not
Non rivalry in consumption – consumption by one person doesn’t reduce consumption for others
Examples – street lighting, national defence

14. Public goods and Market Failure
You cant get an individual to pay for public goods as others can get the benefits from consumption without paying
Private companies will not supply public goods as they don’t make an economic profit on them
Public goods are only supplied by the government and financed through taxation

15. Private goods Private goods have the following characteristics:
Excludability – if you don’t pay you can be excluded from consuming the product
Rivalry – the consumption of one person reduces the amount available for others to consume
Rejectability – you can choose not to consume them and therefore reject them

16. Merit goods
Merit goods are where social benefits exceed social costs – they generate positive externalities
Governments aim to provide more of these goods due to the benefits to society
They may subsidise the production of such goods reducing the marginal costs of consumption and therefore increasing demand
Examples – healthcare, education

17. Merit goods and Market Failure
If the government didn’t step in and produce merit goods then they would be under produced
Attributable to the fact that individuals do not realise the benefits of consuming these goods

18. Demerit goods
Demerit goods are where social costs outweigh social benefits – they generate negative externalities
Governments try and reduce the consumption of these goods through higher taxes
Examples – cigarettes, alcohol

19. Market imperfections
Monopolies – these are often viewed as allocating resources inefficiently as the producer is able to charge higher prices due to being the only producer in the market
Imperfect knowledge of the market can also cause market failure

20. Immobility of factors of production
These can lead to market failure and may be due to:
Occupational immobility – this occurs when there are barriers of mobility between different jobs and different industries
Geographical immobility exists when there are barriers to people of moving to different locations

21. Inequalities
In market economies an individuals ability to consume goods and services is dependent on their income / wealth
An uneven distribution of income / wealth within an economy can result in an unsatisfactory allocation of resources and therefore market failure
In many developing countries income inequality is great therefore resulting in misallocation of resources

22. Summary
Externalities are caused when social benefits / costs are different to private benefits / costs
Positive externalities occur where social benefits are greater than private benefits
Negative externalities occur where social costs are greater than private costs
Cost benefit analysis looks at the costs and benefits of producing / consuming a product
Public goods are goods that are provided by the government e.g. street lighting
Merit goods are where social benefits exceed social costs e.g. healthcare the government encourages people to use these
Demerit goods are where social costs exceed social benefits e.g. smoking the government discourages people to use these through taxation
Market imperfections can be caused by monopolies, imperfect market knowledge and factor immobility which can result in misallocation of resources
Inequalities in wealth and income distribution may result in a misallocation of resources as the rich consume more