Chapter 4, Problem 1DQ

To determine

Market failure.

Explanation of Solution

Market failure can be caused by Externality and Market Power. Externality is when one person actions affect the whole economy. Market Power is when a small group of people have a strong impact on the economy.

A public good is one where consumption in non-excludable and non-rival. Private goods are not profitable because of the free rider problem. If any person desires to start out fireworks and put a charge for the event, the chances of making any good revenue would become dim. In the event of fireworks, one cannot restrict the people outside the event from watching the fireworks as it is non-excludable and it is an example of non-rival because fireworks is visible to everyone. Hence, If 1 person has seen the fireworks; it will not decrease the ability of someone else to see the same fireworks. This is the first type of market failure.

The 2nd potential market failure can be explained as the existence of an externality. Externalities happen when the profit gets accumulated to someone else rather than the original buyer or seller. For example, a person might completely internalize the cost that is incurred by smoking cigarettes, which are the price and the health issues that the person has to face; but the same person cannot internalize the harmful health issues that could harm others, who inhale the smoke from the cigarette.

1^st case: Yes, it is possible for both to occur if an individual feels that the good has a value, such as fireworks, though they still face free-rider issues. For example, a person would like to start a fireworks event and set a charge to see if the event can be made a better show. But as majorities are free-riding from the person’s display, he would start only a small one. If the fireworks display started by that person causes pollution or harm others, then a negative externality might exist.

2^nd case: No, since there is a problem of free-rider organizations that would not be producing any goods. As there are no commodities being produced or consumed, externality factor cannot be considered.

Economics Concept Introduction

Concept introduction:

Market failure: It is a condition, where free markets fail to distribute resources efficiently.

Public goods: Public goods are the goods that have the characteristics of non-rivalry in nature and non-excludability. One person’s consumption should not reduce the availability for other person. It is not advisable to restrict other people to avail the goods they desire.

Externality: Externality refers to the spill over of benefits or cost to the third party other than the immediate market participants.