1. Market Failures and Externalities Unit 2: How Markets Work

2. Market Failures Sometimes markets are not able to provide the goods and services desired by consumers or which can be efficiently produced by suppliers This situation is called a MARKET FAILURE

3. Market Failures – Video Notes Market Failures

4. Externalities Externality – a cost of benefit to an individual or group that is “external” to the market price (also known as a “spillover” effect) Negative = ◦EX: pollution caused by factories producing electrical goods Positive = ◦EX: smaller number of cases of the flu due to consumers getting vaccinated

5. The Market and Externalities Negative externality: ◦The market is producing too much of something (i.e. “overproduction” and “overallocation) ◦The supply curve is too far to the right D Sm Se Q P Pe Pm Qe Qm

6. The Market and Externalities Positive Externality ◦The market is not producing enough of something (i.e. “underallocation” and “underproduction”) Dm Sm De Q P Pe Pm QeQm

7. Private vs. Public Goods Private goods are: ◦Excludable = anyone who does not pay for a good can excluded from doing it ◦Rival in consumption = a good cannot be consumed by more than one person at a time Public goods are: ◦Nonexcludable = even those who do not pay for a good can use it ◦Nonrival in consumption = many people can consume a good without hindering others consumption of the same good

8. Public Goods and the Free Rider Problem This leads to the free-rider problem ◦People can use these types of goods without paying for them Public goods cannot be excluded – therefore there is no efficient way to charge individuals for these types of goods ◦EX: Streetlights