Introduction to TechSoup’s Digital Marketing Services and Use Cases
SH market failure
1. Sometimes the free
market is inefficient
• Learn about common market failures
• Experiment with them
• Graph some production externalities
• Questions
4. Classical Economic assumption:
markets are efficient
+ =
Vilfredo Pareto, 1848-1923
Ultra-liberal economist
Against any form of state intervention,
Particularly in Italy
(Also known for the 80-20 rule
And Pareto distribution, a statistical relationship)
5. A market failure exists when
the free market equilibrium quantity of output is greater or less than
the socially optimal level of output. The free market produces
either too much or too little of a good.
6. Pollution =
Negative effect on
third parties
Street lighting Overconsumption
Information failure
Productive
inefficiency
MC = MR
Immobile labour
Positive production
externality
Pretty garden =
Positive effect on
third parties
UK has 800,000 unfilled vacancies
7. Externalities are effects on third parties who have
no say in the transaction between buyer and seller
Positive externalities
• In consumption (relates to demand)
• In production (relates to supply)
• The good is said to be underproduced
if it has a positive externality
Negative externalities
• In consumption (relates to demand)
• In production (relates to supply)
• The good is said to be overproduced if
it has a negative externality
8. Negative and positive production externalities
• Transaction is between two parties, consumer and firm, who agree on a deal that maximises both their
welfare
• The firm pays the cost of producing the good – this is called the private cost
• A third party ‘pays’ an additional cost – this is an external cost, e.g. nuisance, noise
• Private cost + external cost = social cost (higher than private)
• If the production process causes third parties a benefit, such as pollination, we have a positive production
externality or an external benefit
• Private cost – external benefit = social cost (lower than private)
• Paper, pencils and rulers needed now
9. Negative production externality – drawing it
1. Axes, labels. D is determined by marginal social
benefit, and S is determined by marginal social cost
MSB/
MSC
Q
10. Negative production externality – drawing it
1. Axes, labels. D is determined by marginal social
benefit, and S is determined by marginal social cost
2. Demand (MSB) is unaffected by external costs
MSB/
MSC
Q
D=MSB
11. Negative production externality – drawing it
1. Axes, labels. D is determined by marginal social
benefit, and S is determined by marginal social cost
2. Demand (MSB) is unaffected by external costs
3. In a perfect market, S is based on the firm’s marginal
private cost of producing the good
MSB/
MSC
Q
D=MSB
S=MPC
12. Negative production externality – drawing it
1. Axes, labels. D is determined by marginal social
benefit, and S is determined by marginal social cost
2. Demand (MSB) is unaffected by external costs
3. In a perfect market, S is based on the firm’s marginal
private cost of producing the good
MSB/
MSC
Q
D=MSB
S=MPC
Q
P
13. Negative production externality – drawing it
1. Axes, labels. D is determined by marginal social
benefit, and S is determined by marginal social cost
2. Demand (MSB) is unaffected by external costs
3. In a perfect market, S is based on the firm’s marginal
private cost of producing the good
4. We add the marginal external cost (MEC)
MSB/
MSC
Q
D=MSB
S=MPC
Q
P
14. Negative production externality – drawing it
1. Axes, labels. D is determined by marginal social
benefit, and S is determined by marginal social cost
2. Demand (MSB) is unaffected by external costs
3. In a perfect market, S is based on the firm’s marginal
private cost of producing the good
4. We add the marginal external cost (MEC)
5. This gives us the ‘correct’ supply curve based on
marginal social cost to society (MSC)
MSB/
MSC
Q
D=MSB
S=MPC
MSC
Q
P
15. Negative production externality – drawing it
1. Axes, labels. D is determined by marginal social
benefit, and S is determined by marginal social cost
2. Demand (MSB) is unaffected by external costs
3. marginalIn a perfect market, S is based on the firm’s
marginal private cost of producing the good
4. We add the marginal external cost (MEC)
5. This gives us the ‘correct’ supply curve based on
marginal social cost to society (MSC)
6. Correct P is higher and Q lower now
7. The good is overproduced at Q
MSB/
MSC
Q
D=MSB
S=MPC
MSC
Q
P
P
Q
16. Positive production externality – drawing it
1. Axes, labels. D is determined by marginal social
benefit, and S is determined by marginal social cost
MSB/
MSC
Q
17. Positive production externality – drawing it
1. Axes, labels. D is determined by marginal social
benefit, and S is determined by marginal social cost
2. Demand (MSB) is unaffected by external costs
MSB/
MSC
Q
D=MSB
18. Positive production externality – drawing it
1. Axes, labels. D is determined by marginal social
benefit, and S is determined by marginal social cost
2. Demand (MSB) is unaffected by external costs
3. In a perfect market, S is based on the firm’s marginal
private cost of producing the good
MSB/
MSC
Q
D=MSB
S=MPC
19. Positive production externality – drawing it
1. Axes, labels. D is determined by marginal social
benefit, and S is determined by marginal social cost
2. Demand (MSB) is unaffected by external costs
3. In a perfect market, S is based on the firm’s marginal
private cost of producing the good
MSB/
MSC
Q
D=MSB
S=MPC
Q
P
20. Positive production externality – drawing it
1. Axes, labels. D is determined by marginal social
benefit, and S is determined by marginal social cost
2. Demand (MSB) is unaffected by external costs
3. In a perfect market, S is based on the firm’s marginal
private cost of producing the good
4. We take away the external benefit
MSB/
MSC
Q
D=MSB
S=MPC
Q
P
21. Positive production externality – drawing it
1. Axes, labels. D is determined by marginal social
benefit, and S is determined by marginal social cost
2. Demand (MSB) is unaffected by external costs
3. In a perfect market, S is based on the firm’s marginal
private cost of producing the good
4. We take away the external benefit
5. This gives us the ‘correct’ supply curve based on
marginal social cost to society (MSC)
MSB/
MSC
Q
D=MSB
S=MPC
MSC
Q
P
22. Positive production externality – drawing it
1. Axes, labels. D is determined by marginal social
benefit, and S is determined by marginal social cost
2. Demand (MSB) is unaffected by external costs
3. In a perfect market, S is based on the firm’s marginal
private cost of producing the good
4. We add the external cost (MEC)
5. This gives us the ‘correct’ supply curve based on
marginal social cost to society (MSC)
6. Correct P is lower and Q higher now
7. The good is underproduced at Q
MSB/
MSC
Q
D=MSB
S=MPC
MSC
Q
P
P
Q
23. Welfare in a perfect market
1. Consumer surplus and producer surplus together
make up the total welfare
MSB/
MSC
Q
S=MPC
Q
P
D=MSB
24. Positive production externality –
Consumer and producer surplus if P is correct
1. Consumer and producer surplus together are the total
welfare gained in this society
2. Welfare is maximised when P and Q are at their
optimal level where MSC = MSB
MSB/
MSC
Q
D=MSB
S=MPC
MSC
Q
P
P
Q
25. Positive production externality –
Consumer and producer surplus
1. Welfare is lost when P and Q are at their suboptimal
levels where MPC = MSB
2. This is known as welfare loss or deadweight loss.
MSB/
MSC
Q
S=MPC
MSC
Q
P
P
Q
D=MSB
26. Where does that welfare triangle come from?
• Video
• https://www.youtube.com/watch?v=U0nfsAoCyA0
