Market Failures
Mr. Bammel
Demand Side Market Failures
 Happens when the demand curve does not reflect the
consumer’s willingness to pay for a good or service
 Sometimes this occurs because it is impossible to
charge what consumer’s are truly willing to pay for a
good or service;
Supply Side Market Failures
 Happens when the supply curve does not fully display
costs in producing a good or service;
 Basically the market is unable to weigh all costs or
benefits in production.
Consumer Surplus
 The difference b/w the price a consumer is willing to
pay and what they actually pay, equilibrium price;
 Because the consumer only pays the Eprice, the surplus
is in how much more they are willing to allocate in
terms of their income to that specific product;
Consumer Surplus on the D
curve
Producer Surplus
 The difference b/w the actual price producers receive
and the maximum acceptable price that consumer
would have to pay the producer to make the
particular unit or output available (more simply put,
the marginal cost to produce the product)
 Minimum accepted can also be seen as the
opportunity cost of choosing not to allocate
resources differently;
Producer Surplus on the SCurve
Maximizing Efficiency
 Maximum efficiency is where the largest possible
consumer and producer surpluses are combined;
 Total Surplus =
Demand Surplus +
Producer Surplus
Efficiency Losses (Deadweight
Losses)
 If Quantity is under-produced or over-produced then
there is efficiency loss;
 When under-production occurs, the resources that
should have gone to producing this product have
gone to producing another product with less utility
for society;
 When over-production occurs, the benefits gained of
these units are less than other products that should
have been made instead;
Public Goods and Externalities
 Each individual person will be assigned one of these two
types of Market Failures (public goods and externalities);
 You will be asked to read your section in the text and then
create a poster with all the important concepts associated
with the topic;
 You will want to: use graphs, examples, explanations, etc.
 Your poster should be able to show understanding of the
topic you are focusing on.
 You will be given a quiz grade for the assignment.
Public Goods
 A Demand side market failuredemand curves fail to
represent consumers full willingness to pay for a
good or service; not all net benefits are produced
(underreported demand)
 Extreme forms are in public goods b/c markets may
fail to produce any of the public good b/c its demand
curve may reflect none of the willingness to pay;
Private Good Characteristics
 Distinguished by:
 Rivalry  one person buys a product and therefore
another cannot;
 Excludability  sellers can keep those who do not pay
from being able to gain utility from it;
A competitive market not only allows private goods in the
market but allocates resources efficiently (no
overproduction or underproduction)
Public Goods Characteristics
 Distinguished by
 Nonrivalry  one person’s use will not keep another person’s
consumption from occurring;
 Nonexcludability  no effective way of excluding individuals
Creates a Free-Rider problem, once a product is produced there
will be no effective way to keep it from nonpayers;
Free Riding will produce less demand for the product b/c all free
riders are not expressed in the market;
Optimal Quantity of a Public Good
 Government must try to estimate the demand for a
public good;
 Comparing the MB of an added unit of the good
against the MC of providing it; What we call CostBenefit Analysis;
 Finding a point of MB = MC;
MC – MB rule
 Helps analyze which plan provides the maximum
excess of total benefits over total costs, societies max
net benefits;
 If the MC of a proposed government program
exceeds its marginal benefit, then the proposed
public program should not be undertaken; Vice Versa;
 Economy in government is allocating resources
between the private and public sectors and among
public goods to achieve maximum net benefit.
Quasi-Public Goods
 Goods and services that could be produced and
delivered in such a way that exclusion would be
possible; Could be priced and sold privately, but
because benefits would create underproduction the
government provides them; Education, streets,
police, fire protection, etc.
Public Good Reallocation Process
 By taxing, the government takes money out of our
hands to spend on our own private needs and
allocates that spending to public and quasi-public
goods;
Externalities
 When costs or benefits “spillover” to someone other
than the immediate buyer or seller;
 Negative (costs) Externalities  an overproduction of
the related product occurs and there is an
overallocation of resources to this product;
 Positive (benefits) Externalities  underproduction
and underallocation of resources result when positive
externalities are present;
Negative Externalities
 Supply side market failures; producers not taking into
account problem with production;
 Producers are shifting some of the costs onto
someone else, thus their supply line is too far to the
right; Supply line is not truly capturing all costs;
Graphing Negative Externalities
Positive Externalities
 Demand-side market failures; fails to account for all
the total benefits of market;
 Markets, therefore, fail to produce all units for which
benefits exceed costs; society misses out on potential
net benefits;
Graphing a Positive Externality
Coase Theorem
 Conceived by Ronald Coase of the University of Chicago;
 Given: Property ownership is clearly defined, number of
people involved is small, and bargaining cost are
insignificant; government is not needed for fixing the
externality.
 He believed government should merely encourage
individual bargaining; where because self-interest is at
stake, a mutual agreement will present itself to the
externality;
Government Intervention
 To help achieve economic efficiency when
externalities affect large numbers of people or when
community interests are at stake;
 To counter negative externalities  use legislation
limiting the activity and taxes;
 To counter positive externalities  use subsidies or
public goods;
 Optimal reduction of an externality occurs when
society’s MC = MB;