Lecture Economics (19/e) - Chapter 5: Market failures: Public goods and externalities

Competitive markets usually do a remarkably effective job of allocating society’s scarce resources to their most highly valued uses. Thus, we begin this chapter by demonstrating how properly functioning markets efficiently allocate resources. We then explore what happens when markets don’t function properly. In some circumstances, economically desirable goods are not produced at all. In other situations, they are either overproduced or underproduced. This chapter focuses on these situations, which economists refer to as market failures.

Externalities

05

McGraw­Hill/Irwin         Copyright © 2012 by The McGraw­Hill Companies, Inc. All rights reserved.

amount of the product

what they are willing to pay for the product

paying

the full cost of producing its output

good are not reflected in the supply

consumers full willingness to pay

of production

is willing to pay for a good and what the consumer actually pays

the maximum price

LO2

D

Q 1

P 1

Consumer Surplus

Equilibrium Price

5-7

producer receives and the minimum price they would accept

price

LO2

S

Q 1

P 1

Equilibrium price

Producer surplus

5-9

S

Q

P 1

D

Consumer surplus

Producer surplus

Quantity (bags)

Efficiency Losses

LO2

c

S

Q 1

Q 2

D

b d

a

e

Efficiency loss from underproduction

5-11

c

S

D

b

f a

g

Efficiency loss from overproduction

Private Goods

Public Goods

good production

produced

output of more public goods

party external to the transaction

Government Intervention

(a)

Negative externalities

D

S

S t

Overallocation

Negative externalities

Q o Q e

P

a

c b

(b)

Correct externality with

tax

D

S

S t

Q o Q e

P

0

Q

a

T

LO4

Methods for Dealing with Externalities

Negative externalities

overallocation of resources

1 Private bargaining

2 Liability rules and lawsuits

3 Tax on producers

4 Direct controls

5 Market for externality rights

Positive externalities

(spillover benefits)

Underproduction of output and therefore

underallocation of resources

1 Private bargaining

2 Subsidy to consumers

3 Subsidy to producers

4 Government provision

5-19

correcting externalities

existence and cause

politics