Market Failure and the role of Government DR

Externalities �An externality occurs when some of the costs or the benefits of a

Negative Externalities �Negative externalities, or spillover costs, are production or consumption costs that affect

Positive Externalities �Positive externalities are spillover production or consumption benefits conferred on third parties

Government Intervention �When externalities affect large numbers of consumers, government intervention may be needed

Cont… Direct controls and taxes raise the marginal cost of production of firms. �This

Cont… �There are three options to correct the underallocation of resources: �Subsidies to buyers

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Market Failure and the role of Government DR MD MASROOR ALAM ASSISTANT PROFESSOR DEPT OF ECONOMICS, CMB COLLEGE, DEORH, GHOGHARDIHA B. A Third year Eco H Public Economics

Externalities �An externality occurs when some of the costs or the benefits of a good are passed on to or “spill over to” someone other than the immediate buyer or seller. �Externalities can be positive or negative and can affect production or consumption.

Negative Externalities �Negative externalities, or spillover costs, are production or consumption costs that affect a third party without compensation. �When negative externalities occur, the producers’ supply curve lies to the right of the full-cost supply curve. �The equilibrium output is greater than the optimal output; resources are overallocated to the production of this commodity.

Positive Externalities �Positive externalities are spillover production or consumption benefits conferred on third parties without compensation from them. �When positive externalities occur, the market demand curve lies to the left of the full-benefits demand curve. �The equilibrium output is less than the optimal output; the market fails to produce enough of the good.

Government Intervention �When externalities affect large numbers of consumers, government intervention may be needed to achieve economic efficiency. �For negative externalities, direct controls (pass legislation limiting an activity) and specific taxes can be used to counter the spillover costs. �For positive externalities, government can provide subsidies to buyers or sellers or provide the product for free or for a minimal charge.

Cont… Direct controls and taxes raise the marginal cost of production of firms. �This causes the supply curve to shift to the left, thus correcting the over allocation of resources cause by negative externalities. Output is reduced to its optimal level.

Cont… �There are three options to correct the underallocation of resources: �Subsidies to buyers �Subsidies to sellers �Government provision of quasi-public goods �Subsidizing consumers causes the demand curve to shift rightward whereas subsidies to producers shifts the supply curve rightward.