1. MARKET FAILURE In the real world,
market fails to achieve social efficiency.
SOURCES OF MARKET FAILURE:
Existence of Market Power (Imperfect Competition)
Existence of Externalities
Existence of Public & Merit Goods

2. Market power => __________
Existence of Market Power
Recall: Social efficiency
MSB = MSC
Market power => __________
(Imperfect Competition)
=> ___________________

3. Existence of Market Power
Example: Monopoly
Eqm: MR = MC
PC: MR = AR = MSB
MC = MSC
=> MSB = MSC
at o/p = Q2
Monopoly:
price = P1, o/p = Q1
=> P1 > MC1
=> MSB > MSC
=> social inefficiency $
MC = MSC P1
MSB=MSC
MC1 MR
AR (P)=MSB
Qty Q1 Q2

4. Welfare Loss under monopoly$ MC MR
Deadweight
welfare loss
Consumer
surplus a Pm Qm c
Ppc
Producer
surplus b
AR = D O
fig
Qpc Q

5. Existence of Externalities
_____________________ to society, over & above those experienced by the individual producer & consumer
Drive a ____________________
- between MSC & MPC
- between MSB & MPB
MSC = MPC + _____
MSB = MPB + _____

6. Existence of Externalities
Two types of externalities:
The effects of a decision by consumers and producers that has an impact on a third party
Positive Externalities – _______________ on third parties
Negative Externalities – _____________ by third parties

7. Existence of Externalities
Costs and benefits in production:
External costs in production – ____________
e.g. air and water pollution, congestion, noise, pollution
External benefits in production – __________
e.g. human resource development, research and development in industry

8. Existence of Externalities
Costs and benefits in consumption:
External costs in consumption – ____________
e.g. passive smoking, litter, noise
External benefits in consumption – __________
e.g. preventative health care – vaccinations, public transport, attractive gardens, bathing regularly!

9. Existence of Externalities
Our Focus:
Case a: Negative Externality:
External costs in production – MSC > MPC
Case b: Positive Externality
External Benefits of Consumption - MSB > MPB

10. Negative Externality Case a: External Costs of Production
Example: Pollution -> MSC > MPC [ MSC = MPC + MEC ] $
MSC
SS (MPC)
MEC
Socially optimum
o/p = Q2
where P = MSC
However, firm produces at Q1
=> _____________ P2 P1
DD (MPB = MSB) Q2 Q1
QUANTITY

11. Positive Externality Case b: External Benefits of Consumption
Eg: Public Transport -> MSB > MPB [ MSB = MPB + MEB ] $
(MSC = MPC) SS
Socially optimum
o/p = Q1
where P = MSB
However, consumption level at Q2
=> __________________ P1
MEB P2
MSB
DD (MPB) Q2 Q1
QUANTITY

12. Mindmap of Externalities