Pareto Optimality exists whenever markets are in equilibrium with no external influences or effects.
Community Surplus is maximized under P.O.
Market failure exists whenever community surplus (producer consumer surplus) fails to be maximized.
3 Another View of Market Failure
Baumol Blinder (p. 312)
Markets have several problems that can lead to failure
Severe bus cycle
Monopoly inefficient allocation of resources
Public goods underprovided
Present vs future allocation of resources
Public personal services can become expensive requiring government intervention
4 Key Terms
Marginal Social Cost
Marginal Social Benefit
Positive / Negative
Marginal Social Cost / beneift
Marginal Private Cost / benefit
5 Types of Market Failure
IB Course companion pp 135 - 145
Imperfect competition (monopoly) 135
Lack of Public goods (136)
Under-supply of merit goods (137)
Oversupply of demerit goods (137)
Externalities (138 - 145)
6 Imperfect Competition
Whenever one firm acts with monopoly power it does two things
It raises prices as high as possible
It restricts production
Both actions increase revenute profits for the firm but lead to market failure by
Reducing Community Surplus (see graph p. 135)
Reducing total production so that all those who want and should be able to afford the good cannot do so.
7 Lack of Public Goods - 1
Public Goods Goods which are beneficial to society but which would not be provided in a market.
Non-excludable I cant prevent anyone from enjoying benefits of them (think national defense)
Non-rivalrous One person consuming the good doesnt prevent anyone else from consuming it also (think flood control)
8 Lack of Public Goods 2
Governments try to solve this problem by
Providing the public goods themselves
Subsidizing private firms to provide the good for society as a whole.
9 Undersupply of Merit Goods
Merit Goods They are the goods that the government thinks provide positive benefits for both the people that use them and society as a whole and therefore they think that such goods should be consumed to a greater degree.
Governments attempt to increase the supply and therefore the consumption of merit goods.
Examples eduation health care sports facilities the opera. (p. 136)
10 Oversupply of Demerit Goods
Demerit goods they are the goods that the government thinks are bad both for people who consume them and for society as a whole therefore the government would like to see them consumed to a lesser degree or not at all.
Examples cigarettes alcohol hard drugs and child pornography. (p. 137)
11 Points to Remember
All public goods are merit goods.
Highly desirable merit goods (e.g. education) will often be provided at no direct cost to the consumer.
Less desirable merit goods will be subsidized less heavily.
Highly dangerous demerit goods will be outlawed.
Less dangerous demerit goods will be heavily taxed by the government.
12 Externalities - 1
Anytime the production or consumption of a good imposes a cost or benefit on a third party an externality happens.
If the externality is a cost we call it negative. (auto production air pollution)
If the externality is a benefit we call it positive. (Intel in Folsom volunteer programs in the Folsom schools)
Negative externalities impose an additional cost on society known as the marginal private cost.
Marginal social cost is actually equal to marginal private cost plus or minus any externalities involved. (p. 138)
So too marginal social benefit is equal to the marginal private benefit plus or minus any externalities. (p. 138)
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