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A.P. Microeconomics. Warm Up : for each of the following scenarios identify and explain briefly which market failure is being described: An auto repair shop convinces you that you need a $2,000 valve job, when all you really need is an oil change.

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A.P. Microeconomics

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A.P. Microeconomics

Warm Up:for each of the following scenarios identify and explain briefly which market failure is being described:

An auto repair shop convinces you that you need a $2,000 valve job, when all you really need is an oil change.

Everyone in the neighborhood would benefit if an empty lot were turned into a park, but no entrepreneur will come forward to finance the transformation.

Someone who lives in an apartment building buys a Wayne Newton album and blasts it until 3am each night.

The only two airlines flying directly from Buffalo to Albany make an agreement to raise their prices.

Market Failures

  • In a competitive market, the firms and the households determine the supply and demand of inputs and outputs; in other words, they determine the price and quantity of all.

  • However when the market cannot determine the terms of exchange – price, quantity, location, service, financing, etc. – and/or one party is not willing or able to pay the price, the market fails.

  • Thus there is a need and function for ____________________________.


Results of Externalities

  • Externalities:

    • A cost or benefit resulting from some activity or transaction that is imposed or bestowed on parties not involved with the activity/transaction

Pollution is the classic example, but there are many others: noise, congestion, distaste

Results of Externalities

  • Ex) an economically successful business in production pollutes the land by seeping chemicals into the local water supply.

  • Who Pays the Price?

  • What should government do?

Social Costs

  • Since externalities are those costs not incurred by the buyer or the seller of a market transaction (the costs are incurred by the public), then social costs are equal to private costs and the value of the externalities. (SC = MC + externality)

  • Thus we can distinguish marginal private costs (MPC or MC) from marginal social costs knowing the MSC > MC (private) since marginal social costs incorporate marginal private costs. These distinctions will serve us well when we discuss the government, taxes and subsidies.

Social Costs

  • For example, social costs will equal private costs when government either ___________________ negative externalities or _________________________ positive externalities by the amounts of the externalities.

  • In this way, the government hopes to move the markets to some level of efficiency to compensate for market failure.



Social Costs

  • What is a tax?

  • What is a subsidy?

Government charge on households & firms

Government payment to households & firms

Need for Government

  • Market failure also refers to failure of the market mechanisms to achieve optimal or efficient outcomes. An efficient social outcome would be when _____________________________ (MSB) equals _________________________ (MSC). Therefore, market failure to produce efficient outcomes becomes a general basis for government intervention. A complete market failure to find MSB = MSC for certain goods is the case for a public good.For Example:

Marginal Social Benefit

Marginal Social Cost

Group Activity

Recreate the 4 square for your groups market failure.

NO notes!!!

  • Monopoly

  • Public Good

  • Imperfect Information

  • Externality

If I choose your group’s poster to hang up, you will be exempt from the Chap 11 outline!!

This will be graded and added to your homework grade!!

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