Lecture Essentials of economics (3/e): Chapter 5 - Brue, McConnell, Flynn

Chapter 5 - Market failures: Public goods and externalities. This chapter seeks to define a market failure and the consequences of a market failure. The chapter begins by looking at the demand side of market failures, the supply side of market failures, and the inefficiencies found.

amount of the product

what they are willing to pay for the

product

paying

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the full cost of producing its output

good are not reflected in supply

consumers, full willingness to pay

of production

Private Goods Characteristics

Willingness to Pay (Price)

(3) Benson’s Willingness

to Pay (Price)

(4) Collective Willingness

output of more public goods

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Cost-Benefit Analysis for a National Highway Construction Project

(in Billions)

(1) Plan

(2) Total Cost of Project

(3) Marginal Cost

(4) Total Benefit

(5) Marginal Benefit

(6) Net Benefit (4) – (2)

A: Widen existing

• A cost or benefit accruing to a third party

external to the transaction

• Positive externalities

• Too little is produced

• Demand-side market failures

• Negative externalities

• Too much is produced

• Supply-side market failures

Underallocation

Positive Externalities

provision

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T

(a) Positive externalities

0

St

Underallocation

Positive externalities

to consumers 0

to producers 0

Methods for Dealing with Externalities

Problem Resource Allocation Outcome Ways to Correct

Negative

externalities

(spillover costs)

Overproduction of output and therefore overallocation of

of Pollution Abatement

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costs that taxes impose on society

Regressive Taxes

increase as income increases

declines as income increases

stays the same as income

increases

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States

Type of tax Probable Incidence

Personal

of the tax levied on their employers

Corporate

income tax Short run: Full tax falls on owners of the businessesLong run: Some of the tax may be borne by workers

through lower wages

Specific excise

taxes Taxes fall on consumers, producers, or both, depending on elasticity of supply and demand

Tax Progressivity in the United 

States

(1) Total Taxable

Income

(2) Marginal Tax Rate %

(3) Total Tax

on Highest Income in Bracket

(4) Average Tax Rate

on Highest Income in Bracket

• Federal tax system is progressive

Economy

correcting externalities

existence and cause

politics

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