Market Failure and Externalities #1

An externality...

• is a type of market failure.

• causes markets to allocate resources efficiently.

• strengthens the role of the “invisible hand” in the marketplace.

• affects producers but not consumers.

Private markets fail to account for externalities because...

• externalities don't occur in private markets.

• sellers include costs associated with externalities in the price of their product.

• decisionmakers in the market fail to include the costs of their behavior to third parties.

• the government cannot easily estimate the optimal quantity of pollution.

When a market is characterized by an externality, the government...

• can correct the market failure only in the case of positive externalities.

• can correct the market failure only in the case of negative externalities.

• can correct the market failure in the case of both positive and negative externalities

• cannot correct for externalities due to the existence of patents.

Which of the graphs show a positive externality of production?

• A

• B

• C

• D

Which of the graphs show a positive externality of consumption?

• A

• B

• C

• D

Which of the graphs show a negative externality of consumption?

• A

• B

• C

• D

Which graph illustrates the benefits gained to the community when households put up xmas lights on their house?

• A

• B

• C

• D

Which graph illustrates the costs to society when production of a good leads to harmful air pollution?

• A

• B

• C

• D

Which graph illustrates the production of a new technology that can be used to improve other businesses?

• A

• B

• C

• D

A positive externality...

• causes the product to be overproduced.

• provides an additional benefit to market participants.

• benefits consumers because it results in a lower equilibrium price.

• provides benefits to a 3rd party not involved in the market transaction