Chapter 31, Problem 1VQP

To determine

Identify the market failure through negative externality.

Explanation of Solution

The major reason for market failure is negative externality, that is, a third party suffers from the cost that arises from a market transaction. It can be represented graphically as follows:

According to the figure, initially the market at equilibrium E1, the marginal benefit is equal to the marginal private cost.  Also, produce output Q1 known as the market output. At E2 equilibrium, the market produces socially optimum output where the marginal benefit is equal to marginal social cost. The benefit of market moving from E1 to E2 is represented by the area E1Q1Q2E2 and the cost from the movement is Q1Q2E2E3. From the movement, from Q1 output to Q2 output, the cost is greater than the benefit and it leads to the market failure, which is represented by triangle E1E2E3.

Economics Concept Introduction

Market failure: Market failure is a worsen situation in the economy, which arises when the allocation of goods and services in the market is inefficient.

Negative externality: Negative externality is the cost that is suffered by any individual when there is a transaction that occurs between a producer and a consumer.