POE Market Failures

Apuntes

Introduction to Economics Market Failures April 24, 2025 1 / 14 Contents ▶ Externalities ▶ Negative Externalities ▶ Positive Externalities ▶ The Coase Theorem ▶ Transaction Costs ▶ Addressing Market Failures: Interventions 2 / 14 Externalities An externality arises when a person engages in an activity that influences the well-being of a bystander who neither pays nor receives compensation for that effect. ▶ If the impact on the bystander is adverse, it is known as a negative externality. If it is beneficial, it is called a positive externality. In the presence of externalities, the market equilibrium fails to maximize the total benefit to society as a whole. This is because buyers and sellers neglect the external effects of their actions when deciding how much to demand or supply. ▶ Self-interested firms producing paper might not consider the full cost of the pollution they generate, and consumers of paper might not consider the pollution costs they contribute to through their purchasing decisions. 3 / 14 Negative Externalities Suppose that aluminum factories emit pollution: for each unit of aluminum produced, a certain amount of smoke enters the atmosphere. Since this smoke pos...