Unit 2 Microeconomics(market failure)

Optimal Social Quantity​

MSC (Marginal Social Cost)

MPB (Marginal Private Benefit)

MPC (Marginal Private Cost)

MSB (Marginal Social Benefit)

The cost for firms to produce an additional unit of a good or service

The total cost to society is when an additional unit of a good or service is produced. MSC includes MPC.​

The benefit to consumers of consuming an additional unit of a good or service.

The total benefit to society is when an additional unit of a good or service is consumed.

Optimal Social Quantity​

Equilibirum ​


MSB = MSC​

Merit Goods

Demerit Goods

Goods that are beneficial to the individual and society ​


as a whole and are usually, under-provided.

Goods that are harmful to the individual and society as a whole and are usually, over-provided.

Externalities​

When third parties, who are uninvolved, are affected by the benefits and costs involved in producing or consuming a particular good.

Four Types of Externalities (production=S, consumption=D)​

Negative externalities of production​ MSC>MPC

Positive externalities of production​ MSC<MPC

Positive externalities of consumption​ MSB>MPB

Negative externalities of consumption MSB<MPB

Negative Externality of Production​

The production process of a good or service generates a negative effect on a third party or on society as a whole.

Private firms do not take the additional costs on society into consideration during production.​

Negative Externality of Production​

In the graph below, a typical company is making coal and is a significant contributor to air pollution in the area.

The firm will only take into consideration their private benefit and costs when determining how much to produce. The cost to society is much higher.​

Government Responses​

Carbon Tax​

Tradable Emission Permits​

Legislation​

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Pass laws regarding environmental standards that firms must comply with. (Machinery upgrades, air filters, disposal requirements)​

Pros: Easy to Apply​

Cons: Cost of production increases -> unemployment potential, cost of enforcing policy

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Impose a tax on the firm per unit of output produced. ​

Pros: Government Revenue, Easy to Apply​

Cons: Difficult to measure, Difficult to calculate tax​

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Permission to pollute permits that enforce a quota of emissions. An eco-friendly firm can sell its permit for profit.​

Pros: Encourages firms to lower cost, free-market sets price of a permit, cooperation among businesses​

Cons: Difficult to set an acceptable level of pollution, Difficult to measure pollution​

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Positive Externality of Production​

The production process of a good or service generates a positive effect on a third party or on society as a whole.

Due to it's a positive effect on society, MSC is less than than MPC.​

Please note: This is still an inefficient allocation of resources but, a potential welfare gain.​Once again, production externalities ALWAYS affect costs/supply.​

Government Responses​

The goal is to increase the production for the benefit of society.​

Direct Government Provision​

Subsidizing Firms​

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Pros: Encourages promotion of the industry and lowers costs for firms.​

Cons: The opportunity cost of using government funds, (may have to give up other things such as healthcare)​


Cons: High costs and opportunity cost, lack of expertise by the government, private firms discouraged from joining market

Pros: Government is in full control ​

Negative Externality of Consumption

The consumption of a good or service generates a negative effect on a third party or on society as a whole.​


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Due to its negative effect on society, MSB is lower than MPB. Consumption is greater than it SHOULD BE. The good is over-allocated.​

ATTENTION​


Externalities of consumption focus on Demand/Benefits.

Therefore, MSC and MPC will always be equal.

Government Responses​

The goal is to decrease consumption for the benefit of society.​

Regulation or Ban​

Negative Advertising​

Indirect Taxes​

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Taxes designed to correct negative externalities are called Pigouvian Taxes​

Pros: Increases the cost of the good quickly, Government Revenue​

Cons: Addictive goods are demand price inelastic, creates black markets​

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A regulation or full ban to make the product illegal. (Non-smoking Areas)​

Pros: Reduce Demand, low cost​

Cons: Slow to implement, Government Spending, Enforcing regulations, anger from consumers regarding free-will.

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The government could fund negative advertising such as images on packs of cigarettes.​

Pros: Aims to reduce demand naturally​

Cons: High cost and opportunity costs for the government, studies are unclear on how effective advertising is especially on young adults and teenagers.

Positive Externality of Consumption

The consumption of a good or service generates a positive effect on a third party or on society as a whole.​

Due to its positive effect on society, MSB is greater than MPB. Consumption is SMALLER than it should be.

Please note: This is still an inefficient allocation of resources but, a potential welfare gain.​

Once again, consumption externalities ALWAYS affect Demand/Benefits.​

Government Responses​

The goal is to increase the consumption for the benefit of society.​

Direct Government Provision​

Positive Advertisements​

Subsidizing Firms​

Compulsory Legislation​

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Pros: Encourages promotion of the industry and lowers costs for firms.​

Cons: The opportunity cost of using government funds, (may have to give up other things such as healthcare)​

Pros: Government is in full control ​


Cons: High costs and opportunity cost, lack of expertise by the government, private firms discouraged from joining market

Pros: Aim to increase Demand Naturally​


Cons: High costs and opportunity cost

Pros: Shifts demand effectively​


Cons: Government must provide for free, anger from residents, cost of enforcing law

Welfare Gain/Loss Calculation​

Area of a Triangle = 1/2 (base x height)​

Common Pool Resources​

Resources that are rivalrous but non-excludable.​

Rivalrous-A good when consumed, cannot be consumed by another person.

Non-Excludable​-A good that someone cannot be excluded or prevented from using.​

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It would be very difficult to charge a price for these items resulting in overuse and over-consumption which could lead to severe environmental impacts in the long run.

Sustainability​

the ability of the present generation to meet its needs without compromising the ability of future generations to meet their own needs.

Government Responses to Sustainability Threats

Sustainability is of great importance on a national and global level. These resources are not owned by one country, and therefore, international cooperation is key.

International Cooperation​

Countries must cooperate to develop, set, and enforce policies designed to slow, halt, and reverse climate change.

Lack of Shared Responsibility

Inequality of resources

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Political Disagreements

Some governments are more committed than others to reducing environmental impacts and there are different views about which methods are best.

Not all countries have the ability to devote resources to combat climate change. Developing countries find it much more difficult to transition to clean technology and renewable energy

Not all countries produce large CO2 Emissions. The countries most affected are small islands with little/no C02 footprint while those larger countries responsible for large emissions are slow to act.​