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Unit 2 Microeconomics(market failure) - Coggle Diagram
Unit 2 Microeconomics(market failure)
Optimal Social Quantity
MSC (Marginal Social Cost)
The total cost to society is when an additional unit of a good or service is produced. MSC includes MPC.
MPB (Marginal Private Benefit)
The benefit to consumers of consuming an additional unit of a good or service.
MPC (Marginal Private Cost)
The cost for firms to produce an additional unit of a good or service
MSB (Marginal Social Benefit)
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
Goods that are beneficial to the individual and society
as a whole and are usually, under-provided.
Demerit Goods
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
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
Tradable Emission Permits
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
Legislation
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
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
Cons: High costs and opportunity cost, lack of expertise by the government, private firms discouraged from joining market
Pros: Government is in full control
Subsidizing Firms
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)
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.
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
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.
Negative Advertising
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.
Indirect Taxes
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
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
Pros: Government is in full control
Cons: High costs and opportunity cost, lack of expertise by the government, private firms discouraged from joining market
Positive Advertisements
Pros: Aim to increase Demand Naturally
Cons: High costs and opportunity cost
Subsidizing Firms
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)
Compulsory Legislation
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.
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
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.
Inequality of resources
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
Political Disagreements
Some governments are more committed than others to reducing environmental impacts and there are different views about which methods are best.