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Unit 1.4 Market Failure
Negative Externalities
Key terms:
● Marginal Private Benefit: Represents the benefits derived by the private consumers of
a particular good or service. This is the demand for the product.
● Marginal Social Benefit: Represents the benefits derived by the private consumers
plus any external benefits (positive or negative) placed on society deriving from the
good’s consumption. MSB equals the MPB plus any externalities (positive or negative)
that exist.
● Marginal Private Cost: Represents the private costs to the producers of a good or
service associated with the good’s production. This is the supply of the product.
● Marginal Social Cost: Represents the private costs of a good or service plus any
external costs imposed on society by the good’s production. MSC equals the MPC plus
any externalities (positive or negative) that exist.
1. Beef cattle produce methane, a greenhouse gas that contributes to global warming.
a. Describe what makes this an example of a market failure
b. Use marginal benefit and marginal cost analysis to illustrate the market failure in
the graph below. Identify the following on your graph:
■ The equilibrium level of output and price
■ The socially optimal level of output
■ The area of welfare loss at equilibrium
c. Explain how two of the following could be used by government to achieve a more
socially optimal outcome in the market:
■ Corrective taxes
■ Corrective subsidies
■ Government regulation
■ Tradeable permits
2. A rise in the popularity of camping in the summer months increases the chances of
dangerous wildfires that threaten private property in California.
a. Describe what makes this an example of a market failure
b. Use marginal benefit and marginal cost analysis to illustrate the market failure in
the graph below. Identify the following on your graph:
■ The equilibrium level of output and price
■ The socially optimal level of output
■
The area of welfare loss at equilibrium
c. Explain how two of the following could be used by government to achieve a more
socially optimal outcome in the market:
■ Corrective taxes
■ Corrective subsidies
■ Government regulation
■ Tradeable permits
3. The construction of a new dam will wipe out several popular fishing streams, reducing
the number of tourists coming to an area for recreational purposes.
a. Describe what makes this an example of a market failure
b. Use marginal benefit and marginal cost analysis to illustrate the market failure in
the graph below. Identify the following on your graph:
■
■
■
The equilibrium level of output and price
The socially optimal level of output
The area of welfare loss at equilibrium
c. Explain how two of the following could be used by government to achieve a more
socially optimal outcome in the market:
■ Corrective taxes
■ Corrective subsidies
■ Government regulation
■ Tradeable permits
4. Children exposed to the lead paint used by Chinese toy manufacturers become sick.
a. Describe what makes this an example of a market failure
b. Use marginal benefit and marginal cost analysis to illustrate the market failure in
the graph below. Identify the following on your graph:
■ The equilibrium level of output and price
■ The socially optimal level of output
■ The area of welfare loss at equilibrium
c. Explain how two of the following could be used by government to achieve a more
socially optimal outcome in the market:
■ Corrective taxes
■ Corrective subsidies
■ Government regulation
■ Tradeable permits
5. Diamond production often involves the use of unpaid or very poorly paid workers who
work in incredibly dangerous condition.
a. Describe what makes this an example of a market failure
b. Use marginal benefit and marginal cost analysis to illustrate the market failure in
the graph below. Identify the following on your graph:
■ The equilibrium level of output and price
■ The socially optimal level of output
■ The area of welfare loss at equilibrium
c. Explain how two of the following could be used by government to achieve a more
socially optimal outcome in the market:
■ Corrective taxes
■ Corrective subsidies
■ Government regulation
■ Tradeable permits
6. The demand for fur coats and accessories has threatened the wild populations of certain
species of animals.
a. Describe what makes this an example of a market failure
b. Use marginal benefit and marginal cost analysis to illustrate the market failure in
the graph below. Identify the following on your graph:
■ The equilibrium level of output and price
■ The socially optimal level of output
■ The area of welfare loss at equilibrium
c. Explain how two of the following could be used by government to achieve a more
socially optimal outcome in the market:
■ Corrective taxes
■ Corrective subsidies
■ Government regulation
■ Tradeable permits