Understanding Market Failures: Externalities and Information
Market Failures: Externalities and Information
Private Goods
- Consumption by one person prevents consumption by another.
- Exclusive with price: those who don’t pay can be excluded from use.
Public Goods
- Consumption by one person does not prevent consumption by another (non-rival).
- Non-exclusionary by price.
Externalities
An externality is a cost or benefit arising from production that affects someone other than the producer or consumer.
- Positive Externality: A benefit to others.
- Negative Externality: A cost to others.
Private vs. Social Costs of Production
- Private Cost: Cost borne by the producer of a good.
- External Cost: Cost borne by others due to the producer’s actions.
- Social Cost: Total cost to society (private cost + external cost).
Both private and external costs (and thus social cost) increase with increasing production.
Private vs. Social Benefits
- Private Benefit: Profit gained by the producer or consumer.
- External Benefit: Benefit perceived by others as a result of production or consumption.
- Social Benefit: Total benefit to society (private benefit + external benefit).
Asymmetric Information
Asymmetric information exists when information about the quality and characteristics of goods and services, or the actions of economic agents, is not distributed equally between consumers and producers.
Sometimes, the market provides consumers or producers with imperfect information, hindering well-informed decisions.
Private Goods
- Consumption by one person prevents consumption by another.
- Exclusive with price: those who don’t pay can be excluded from use.
Public Goods
- Consumption by one person does not prevent consumption by another (non-rival).
- Non-exclusionary by price.
Externalities
An externality is a cost or benefit arising from production that affects someone other than the producer or consumer.
- Positive Externality: A benefit to others.
- Negative Externality: A cost to others.
Private vs. Social Costs of Production
- Private Cost: Cost borne by the producer of a good.
- External Cost: Cost borne by others due to the producer’s actions.
- Social Cost: Total cost to society (private cost + external cost).
Both private and external costs (and thus social cost) increase with increasing production.
Private vs. Social Benefits
- Private Benefit: Profit gained by the producer or consumer.
- External Benefit: Benefit perceived by others as a result of production or consumption.
- Social Benefit: Total benefit to society (private benefit + external benefit).
Asymmetric Information
Asymmetric information exists when information about the quality and characteristics of goods and services, or the actions of economic agents, is not distributed equally between consumers and producers.
Sometimes, the market provides consumers or producers with imperfect information, hindering well-informed decisions.