Market Failure and the Role of Government

12%-18% of AP Test

The private market FAILS to produce the socially optimal quantity


Marginal social benefit > marginal social cost

Positive externalities (too little)-a party EXTERNAL to the transaction can benefit. Examples: Education & immunizations.

Other terms for positive externality-spillover benefits, external benefits and underallocation.

Correct the externality--Per-unit subsidy the consumer and/or the producer.

Negative externalities (too much)-a party EXTERNAL to the the transaction it negatively impacted or incurs a cost. Example: pollution.

Other terms for negative externality-spillover costs, external costs and overallocation.

Correct the negative externality--per-unit tax, regulate, or cap and trade the consumer and/or the producer.

Public goods

Public versus private goods

Public goods: Non-Rival and Non-Excludable. Example: Military, streetlights, and public parks.

Private goods: Excludable and Rival. Example: Haircut & eating a sandwich

Artificially Scarce (toll goods): Non-Rival & Excludable: Amusement park & movies

Common Good: Non-excludable and rival: Deadliest Catch (seafood).

Provision of public goods

Public policy to promote competition

Antitrust policy: Department of Justice Anti-Trust Division to review market concentration.

Regulation: Price and/or quantity regulation

Income distribution

Equity-Progressive income taxes to help redistribute income and reduce income inequality.

2017 Income Tax Brackets:

Sources of income inequality