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Ch 5 Market Failures: Public Goods and Externalities

Demand-side market failures

happen when demand curves do not reflect consumers' full willingness to pay for a good or service

Supply-side market failures

occur when supply curves do not reflect the full cost of producing a good or service

Consumer Surplus

the difference between the max price a consumer is willing to pay for a product and the actual price that they do pay

Producer Surplue

the difference between the actual price a producer receives and the minimum acceptable price that a consumer would have to pay the producer to make a particular unit of output available

Productive Efficiency

achieved because competition forces orange growers to use the best technologies and combinations of resources available. Doing so minimizes the per-unit cost of the output produced

Allocative Efficiency

achieved because the correct quantity of oranges is produced relative to other goods and services (equilibrium)

Efficiency Losses/Deadweight Loss

reductions of combined consumer and producer surpluses; result from both underproduction and overproduction

Private Goods

goods offered for sale in stores, shops, and Internet

Rivalry in consumption

when one person buys and consumes a product, it is not available for another person to buy and consume


sellers can keep people who do not pay for a product from obtaining its benefits

Public Goods

distinguished by nonrivalry and nonexcludability

Nonrivalry (in consumption)

one person's consumption of a good does not preclude consumption of the good by others. Everyone can simultaneously obtain the benefit from a public good such as national defense, street lighting, etc.


no effective way of excluding individuals from the benefit of the good once it comes into existence. Once in place, you can not exclude someone from benefiting from national defense, street lighting, etc.

Free-rider problem

Once a producer has provided a public good, everyone, including nonpayers, can obtain the benefit

Cost-benefit analysis

deciding whether to provide a particular public good and how much of it to provide

Marginal-cost-marginal-benefit rule

tells us which plan provides the max excess of total benefits over total costs, aka the plan that provides society with the max net benefit

Quasi-public goods

public goods which provide some exclusion such as education, streets, museums, etc.


when some of the costs or the benefits of a good or service are passed onto or "spill over to" someone other than the immediate buyer or seller; can be both + & -

Optimal reduction of an externality

when society's marginal cost and marginal benefit of reducing that externality are equal (MC=MB)

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