•What is market failure

?
What may cause the market to fail?
• What does this
have to do with
allocative
efficiency ?
 Externalities
• Externalities arise whenever the actions of one economic
agent make another economic agent worse or better off,
yet the first agent neither bears the costs nor receives the
benefits of doing so
• Example: a steel plant that pollutes a river used for
recreation.
•
 Externalities may be positive, or it may be
negative.

Externalities
External Marginal Benefit (EMB) an external
benefit or positive externality is a benefit that a
transaction or activity provides to a party that is
not part of the transaction or activity. In other
words, it is a benefit provided to a party not
involved in the production or consumption of a
good but is affected by it.
 Positive
Externality
 • EXTERNAL MARGINAL COST
(EMC):an external COST or
NEGATIVE externality is
a COST that a transaction or
activity provides to a party that
EXTERNALITIES
is not part of the transaction or
activity. In other words, it is a
COST provided to a party not
involved in the production or
consumption of a good but is
affected by it.
Examples:
 • Private Marginal Cost (PMC) is the change in
the producer's total cost brought about by the
production of an additional unit of a good or
service. It is also known as marginal cost of
Cost production. The direct cost to producers of
producing an additional unit of a good

• It is shown using the Marginal Cost Curve

• Private Marginal Benefits(PMB)
are the direct benefits or
satisfaction which the immediate
consumers derive from consuming
the good or service. It is
represented by a demand curve Benefit
• How can we measure satisfaction ?
• It is measured by the amount of
money consumers are willing to pay
for the goods.
The following is • Social Marginal Cost (SMC) =
true: Private Marginal Cost (PMC)+
External Marginal Cost(EMC)
• SMC=PMC+EMC
• This tells us that the difference
between the Social Marginal
Cost and Private Marginal Cost
will give us the External Marginal
Cost (Remember, External
Marginal Cost is a negative
externality)
•Do not move on if
you don’t read it
over again
ALLOCATIVE • ALLOCATIVE
EFFICIECY EFFICIENCY :OCCURS
WITH THE ECONOMY
HAS ACHIEVED AN
OPTIMAL LEVEL OF
OUTPUT. THIS MEANS
THEY ARE NOT UNDER
PRODUCING OR
OVERPRODUCING
• WHAY DOES THE GRAPH ABOVE HAVE MU BECAUSE:

• MU STANDS FOR MARGINAL UTILITY.

UTLILITY IS SATISFACTION REMEMBER!
CAN THE PPF BE
USED TO SHOW
ALLOCATIVE
EFFICIENCY ?
• IS THE ECONOMY OVER
PRODUCING OR UNDER
PRODUCING?
• How will I know ?
 This economy had
achieved the allocative
Whats efficient point.
going
on Supply is equal to
above? demand which is also
called the market
equilibrium.
• Supply and demand curves intersect at the equilibrium
price. This is the price at which the market will operate.
• Where demand and supply intersect
• Because the graphs for demand and supply curves both
have price on the vertical axis and quantity on the
horizontal axis, the demand curve and supply curve for a
particular good or service can appear on the same graph.
Together, demand and supply determine the price and the
quantity that will be bought and sold in a market.
• SO…….
• From the graph above it can be seen that supply is equal to
demand which is also called(market equilibrium ). Market
Equilibrium is equal to the allocative efficient point.
• So this economy has achieved allocative efficiency
It is at that point that
consumer and producer
surplus is maximized.

SO…….it is fair to conclude

that consumer surplus and
producer surplus is equal
to net welfare benefit
• BACK TO THE QUESTION IS THE ECONOMY OVER
PRODUCING OR UNDERPRODUCING ?
 what GOING ON ABOVE?
• The market equilibrium(where supply equals demand) is
at Qmkt.
• There Allocative efficient point is at Qaff
• Therefore, the market equilibrium point is lower that
than the allocative efficient point.
• In other words:
• Qmkt > Qaff therefore,
• THIS ECONOMY IS PRODUCING LESS THAN THE
ALLOCATIVE EFFICIENT OUTPUT
• TheThe
dead weight loss will be the
dead weight loss will
area in pink above.
be the area in pink above.
• Look at the slide below do you
seeLook
it? at the slide below
• It isdo
theyou
areasee it? Below!
in Green

It is the area in Green

Below!
What do you think
overproduction
looks like?
•Try to explain the
graph above in your
own words!!
• So…Market Failure will occur when the market
equilibrium is not equal to the socially optimal level of
output(Allocative efficiency)
• It may occur from overproduction
• It may occur from underproduction
Market failure can
occur from Public
Goods as well.

So…. Please do your

home work on public
goods so we can look at
that next !