Market failure: a misallocation of resources (when goods are allocated at the wrong quantity or price).
Externalities: cost or benefit to a third party from a transaction.
Privatecosts: the cost to the producer e.g. of making the good.
External costs: cost to the third party e.g. neighbours/ taxpayers.
Social costs = private cost + external cost.
Private benefits: the benefit to the consumer e.g. utility/ enjoyment.
External benefits: benefit to the third party e.g. neighbours/ taxpayers.
Social benefits = private benefit + external benefit.
Merit goods such as vegetables have a positive externality in consumption because they benefit the buyer and other parts of society.
Demerit goods such as tobacco have a negative externality in consumption because they cost the buyer and other parts of society.
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Pure public goods are non-rival and non-excludable.
Non-excludability: cannot prevent access e.g. a gate/ barcode.
Non-rivalry: when a good is consumed by one person, it does not reduce benefits others can gain from it (it can be shared without compromise).
Non-rejectability: cannot opt-out and reject its benefits.
A public good may take on some characteristics of a private good and become a quasi-public good (e.g. toll roads).
Technological change is significant (e.g. television broadcast is now excludable).
The free-rider problem occurs when non-excludability leads to a situation in which not enough customers choose to pay for a good, preferring to free ride instead. As a result, the incentive to provide that good through the market disappears, leading to a missing market.
The tragedy of the commons is a situation where there is overconsumption of a particular product / service because rational individual decisions lead to an outcome that is damaging to the overall social welfare (e.g. overfishing).
Information gaps is another cause of market failure.
Symmetric information is when both parties have the same information as each other. Asymmetric information is when one party e.g. buyer has more information than the other e.g. seller.
Information gaps leads to misallocation of resources because people are not able to realise the correct benefits or costs of a transaction.