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    Market failure is the misallocation of resources by the price mechanism.
    I know the idea of externalities but how exactly do externalities create market failure. My book says something regarding how prices don't reflect the costs and benefits to society.

    Can anyone explain this please? Also what else is there to externalities, I've learnt the production/consumption diagrams and the policies that can combat externalities. But should I know the diagrams for each policy?

    Cheers
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    (Original post by UKBrah)
    Market failure is the misallocation of resources by the price mechanism.
    I know the idea of externalities but how exactly do externalities create market failure. My book says something regarding how prices don't reflect the costs and benefits to society.

    Can anyone explain this please? Also what else is there to externalities, I've learnt the production/consumption diagrams and the policies that can combat externalities. But should I know the diagrams for each policy?

    Cheers
    Externalities are defined as third party (or spill-over) effects arising from the production and/or consumption of goods and services for which no appropriate compensation is paid.
    Externalities can cause market failure if the price mechanism does not take into account the full social costs and social benefits of production and consumption.

    Give this article a read, it basically outlines why they create market failure.

    Basically, if you want a quick answer, externalities mean that the producer does not bear all the costs, or buyer does not get all the benefits of the good. Which means that market equilibrium which maximizes the difference between buyer's benefit and producer's cost will not maximize the difference between true benefits and costs.
    Specifically, if there is positive externality, market will produce too little, and if negative - too much.

    I have a YouTube channel with lots of tutorials on things like this, you might find it useful!

    Alex :cool:
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    Because when you have a negative externality for example, this means that the social cost is higher than the private cost. The difference between the social cost and private cost is the externality, or the spill over effect to third parties.
    What this means is that the product is being over produced because the social costs mean people are less likely to buy or use it.
    The product being over produced means that there is allocative inefficiency (if you don't know what this means look it up in your book), because too many scarce resources are being used. This is market failure (the misallocation of resources).
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    (Original post by Alex-Torres)
    Externalities are defined as third party (or spill-over) effects arising from the production and/or consumption of goods and services for which no appropriate compensation is paid.
    Externalities can cause market failure if the price mechanism does not take into account the full social costs and social benefits of production and consumption.

    Give this article a read, it basically outlines why they create market failure.

    Basically, if you want a quick answer, externalities mean that the producer does not bear all the costs, or buyer does not get all the benefits of the good. Which means that market equilibrium which maximizes the difference between buyer's benefit and producer's cost will not maximize the difference between true benefits and costs.
    Specifically, if there is positive externality, market will produce too little, and if negative - too much.

    I have a YouTube channel with lots of tutorials on things like this, you might find it useful!

    Alex :cool:
    How are they different to merit and demerit goods? As merit goods are defined as goods which yield positive externalities and so are underproduced.
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    (Original post by jack0213123)
    How are they different to merit and demerit goods? As merit goods are defined as goods which yield positive externalities and so are underproduced.
    Merit and demerit goods are basically the same positive and negative externalities. So look back at my reply and change positive and negative externalities to merit and demerit goods, if it helps your understanding
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    (Original post by Alex-Torres)
    Merit and demerit goods are basically the same positive and negative externalities. So look back at my reply and change positive and negative externalities to merit and demerit goods, if it helps your understanding
    Thanks a lot, do you know why they are taught as two distinct market failures?
 
 
 
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