Economics: Principles, Problems, and Policies, 19th Edition

Published by McGraw-Hill Education
ISBN 10: 0073511447
ISBN 13: 978-0-07351-144-3

Chapter 5 - Market Failures: Public Goods and Externalities - Questions: 1

Answer

One cause of market failure could be that of positive externalities in consumption. An example of this would be measles vaccines, where the third parties involved would be those who are not vaccinated, who would benefit as the greater the number of people who are vaccinated, the less likely they are to contract measles. This thus causes an underproduction of measles vaccines, as the social benefit of consuming measles vaccine would exceed the private benefit of its consumption, thus society's resources are not allocated efficiently. Another cause of market failure could be that of negative externalities in consumption, as is the case with the consumption of cigarettes. The third parties involved here would be those who inhale the second hand smoke emitted when cigarettes are consumed, and they risk contracting respiratory diseases. This thus causes the social benefit of the good to be less than the private benefit of consuming the good, and the good is over consumed, and too much of society's resources are allocated to the production of cigarettes, thus this represents market failure. These two forms of market failure cannot occur simultaneously, as both of these cases occur in relation to the consumption of a good, and thus one product cannot be both negative and positive in consumption simultaneously.

Work Step by Step

With reference to the diagram above, when there is a positive externality in consumption, the marginal private benefit curve would be above (or rightward) to the marginal social benefit curve, as the optimum consumption is more than the existing consumption as dictated by the market as the third party benefits are not taken into account. Thus, market failure occurs as there is allocative inefficiency. Regarding the diagram below that depicts negative externalities in consumption, the marginal private benefit (or the existing demand curve) would be above than the marginal social benefit, as the third party cost and therefore there is market failure as well. Since both are concerned with the demand curve, they cannot occur together.
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