In our last lesson we defined and introduced the different types of market failures we’ll study in future lessons. The first we examine is negative production externalities, which arise when the production of a good creates spillover costs on society as a whole.
This lesson looks at one market in which negative externalities result from production and carefully walks through how we can use marginal benefit and marginal cost analysis to illustrate and explain this market failure.
Markets are thought to be the most efficient system for allocating society’s scarce resources. However, what if markets FAIL to achieve the efficiency we so desire as a society? Market failures arise when the free market quantity is either greater than or less than the “socially optimal” quantity of a good.
This lesson introduced different ways markets may fail to achieve a socially optimal level of output. In part 2 of this lesson we’ll explore in more detail one type of market failure: negative externalities of production.
When a resource is abundant, it makes sense for it to be cheap. But as the scarcity of a resource (whether it’s renewable or non-renewable) is intensified under the pressure of growing demand and diminishing supply, a market failure arises if an efficient price is note established that assures the resources is consumed at a sustainable quantity. This lesson illustrates a simple supply and demand analysis of the Tragedy of the Commons.
When the buyers or sellers in a market do not know all the same information, it is possible that the equilibrium quantity will be greater than what is best for society. The existence of such “information asymmetry” can lead to market failures, as will be explained in this lesson.
A market failure exists when the private sector fails to produce the socially optimal level of output (where marginal social benefit equals marginal social cost). An extreme form of market failure arises in the case of public goods, which, due to their characteristics, are not provided by the free market at all.
Sometimes the production of a good creates external benefits for a third party, but not often! Businesses do not want to externalize benefits, because this means they aren’t making MONEY from their goods and services! However, sometimes positive production externalities arise. This lesson will explain these situations, give examples, and introduce some of the possible government solutions.
One notable form of market failure arises due to a phenomenon first articulated by American ecologist Garrett Hardin, who warned of the Tragedy of the Commons. In his 1968 essay, Hardin explained that when there exist common resources, for which there is no private owner, the incentive among rational users of that resources is to exploit it to the fullest potential in order to maximize their own self gain before the resource is depleted. The tragedy of the commons, therefore, is that common resources will inevitably be depleted due to humans’ self-interested behavior, leaving us with shortages in key resources essential to human survival.
In this video lesson the market failure of common access resources is explained and applied to three such resources being depleted in an unsustainable manner by the world’s people today: fish in the seas, trees from the forests and air in our atmosphere.
After watching this video, you may find the following blog posts particularly useful in learning and understanding what makes common resources a market failure:
Positive externalities of consumption arise whenever the benefit to society of a particular good exceed the benefits enjoyed by the individual consumers of the good. In other words, if the marginal social benefit exceeds the marginal private benefit, there is a positive externality of consumption. The free market will under-produce and consume such a good.
Sometimes a good’s consumption imposes costs on third parties not involved in the market. Such situations are evidence of a type of market failure known as negative consumption externalities. This lesson introduces the key terms and diagrams required to analyze such market failures and provides several examples and potential solutions.