Market failure: Situation where market outcomes are inefficient, often due to externalities or imperfect information, leading to suboptimal resource allocation.
Externality: The effect of an activity on a third party not compensated or reflected in market prices; can be positive or negative.
Negative externality: External costs imposed on others, such as pollution, causing overproduction relative to social optimality.
Positive externality: External benefits received by others, like education, leading to underproduction without intervention.
Coase theorem: The proposition that if transaction costs are zero, private bargaining can internalize externalities regardless of property rights distribution, achieving efficiency.
1. Under what conditions can private bargaining solve externality problems according to the Coase theorem?
2. What is the primary reason for market failure related to externalities?
3. Which policy instrument is typically used to correct negative externalities such as pollution?
What is market failure and what causes it?
Market failure occurs when market outcomes are inefficient due to imperfections and externalities, leading to socially suboptimal resource allocation.
How do externalities affect market outcomes and what are the types?
Externalities are impacts of individual or firm actions not reflected in market prices, leading to social costs or benefits. Negative externalities cause overproduction, while positive externalities cause underproduction relative to the social optimum.
What are common government interventions to correct externalities?
Government interventions include taxes, subsidies, and tradable permits aimed at internalizing externalities and aligning private incentives with social welfare.
Market failure — definition?
Inefficient resource allocation due to externalities.
Externalities — what?
Costs or benefits not reflected in market prices.
Negative externality — example?
Pollution causing overproduction.
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