Why externalities cause market failure

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The most direct consequence of negative externalities is that the private costs of enterprises are smaller than the social costs. For example, some products pollute the environment by causing sewage. In this way, the private cost of the enterprise is only the manufacturing cost of the product, plus the cost of simple treatment of sewage (some are not treated at all), while the social cost includes the damage of sewage to the environment and people, so the social cost is greater than the private cost.

The criterion of the manufacturer's decision-making is that its own marginal private benefit is equal to the marginal cost of private, while the optimal social outcome is that the marginal social cost is equal to the marginal benefit, so the production of pollutants will be too much (because of the law of diminishing marginal returns of products).

In this way, the deviation from the Pareto optimal level causes the market to fail.

In short, the negative externalities are not reflected in the decision-making of manufacturers, so that the final commodity cannot reflect its true cost, resulting in excessive production and market failure.

When the market fails, the market mechanism cannot effectively allocate resources according to people's wishes, and it is precisely because the market economy cannot achieve the optimal allocation of resources that the state needs to intervene in the market economy in order to achieve the purpose of optimizing the allocation of resources.

The main causes of market failure are: monopolies, public goods, externalities and incomplete information.

Externalities are widespread in the real economy. Both positive and negative externalities can lead to market failures and affect the market's allocation of resources. Since externalities make resource allocation inefficient, in the real economy, both market participants and the public sector govern externalities in various ways, so that resource allocation is at or near the optimal level required by society.

Summary. Hello dear. There are several reasons for market failure.

Due to the existence of externalities or external influences, the market mechanism cannot effectively allocate resources. For producers who generate the external economy, because their private gains are smaller than the social benefits (because the social benefits are equal to the sum of private and external gains, and the external benefits cannot be obtained by the producers through the market**), they lack the motivation to produce, and their output levels will be lower than the optimal output levels of society.

Hello dear. There are several reasons for market failure. Due to the existence of externalities or external influences, the market mechanism cannot effectively allocate resources.

For the producers who produce the external economy, because their private gains are less than the social benefits (because the social income is equal to the sum of private and external benefits, and the external benefits cannot be used as producers through the market), they lack the enthusiasm for production, and their output level will be lower than the optimal output level of society.

The main causes of market failure are monopoly, externalities, public goods and information asymmetry. Market failure refers to the inefficient allocation and allocation of resources or the misallocation of resources due to the inadequacy of the market mechanism. 1. The first reason for the failure of the monopoly market is that the monopoly merchants call for eggplant products to sell, which will lead to low efficiency, excess production capacity, and the optimal allocation of social resources 2. The second reason for the failure of the public goods market is that the economy and society need a class of commodities called public goods.

Public goods are non-exclusive and non-competitive. The non-exclusivity of public goods makes the mechanism of allocation and search to obtain the consumption power of public goods through market exchange fail.

3. ExternalitiesExternalities are the third important cause of market failure. Externality refers to the economic behavior of the two parties to the transaction and is imposed on the other party without exchange.4 Information asymmetryIn the economic society, when the cost of information is very high, it is impossible for information to be evenly distributed, and incomplete information may cause monopoly.

In an economic society, it is conditional for the whole economy to achieve general equilibrium, and for the allocation of resources to reach the Pareto optimal state. These conditions include: economic agents are completely rational, information is complete, the market is completely competitive, and there is no external influence on the behavior of economic agents.

A perfectly competitive market that meets these conditions is obviously unrealistic, and when these conditions are not met, the optimal allocation of resources or the Pareto optimal state is usually not achieved. If the conditions for perfect competition are undermined, or even if there are conditions for perfect competition, the market mechanism cannot achieve the optimal allocation of resources in many cases, and the so-called market failure will occur.

Hello, the main reasons for market failure caused by externalities are: monopolies, public goods, externalities, and incomplete information. Externalities are widespread in the real economy.

Both positive and negative externalities will lead to market failure and affect the allocation of resource renting incentives in the market. Due to the inefficiency of resource allocation due to externalities, both in reality and in the town economy, both market participants and the public sector govern externalities in various ways, so that resource allocation is at or near the optimal level required by society. Method:

**Externalities can be addressed through direct regulation, taxation and subsidies. For behaviors with negative externalities, they can be taxed, and the size of the tax should be equal to the loss that the behavior brings to society. For behaviors with the right externalities, subsidies can be given.

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1. Externalities, also known as externalities, refer to the effects of certain economic activities on agents unrelated to this activity, that is, these activities generate costs that are not borne by producers or consumers (such as negative externalities), or benefits that are not obtained by producers or consumers (called positive externalities).

1. When there are negative externalities, the marginal cost of society is greater than the marginal cost of private, but the marginal benefit of private is still the same as the marginal benefit of social disturbance, so when the marginal cost of private = private marginal benefit, the marginal cost of society is greater than the marginal benefit of society. At this time, from a private point of view, market regulation is beneficial, but from a social point of view, it is not the optimal allocation of resources. This is the market failure caused by externalities.

2. For example, wastewater discharged from a factory built near a river pollutes the river and causes damage to others. The factory discharges wastewater in order to make money from the production of its products, and the relationship between the factory and the customers who purchase its products is a relationship of exchange for money, but the factory may not have to pay any compensation to others for the damage caused by it.

This influence is the external influence of the factory's production. From a private point of view, the allocation of resources is optimal, but from the perspective of society, it is not the optimal allocation of resources.

Second, the external economic effect is an important cause of market failure, and the policies to solve this problem mainly include: taxes and subsidies, direct regulation, and clear property rights and negotiation.

1. The tax and subsidy policy is a means to levy a tax equal to the marginal external cost to the manufacturer that exerts a negative external economic effect, and to give the manufacturer a subsidy equal to the marginal external benefit to the manufacturer that produces a positive external economic effect.

2. Direct regulation is the forcible control of external economic influences through administrative or legal means, and it is also possible to merge economic units that impose and accept external costs or benefits.

Extended Materials. Broken down further, externalities can be further divided into eight types:

1. The external economy of the producer to the producer, such as the relationship between the owner of the fruit orchard and the owner of the apiary;

2. The external economy of producers to consumers, such as the impact of garden-style factories on residents in surrounding residential areas;

3. Consumers greatly increase productive investment in the external economy of producers, such as the improvement of the living environment;

4. The external economy of consumers to consumers, such as the influence of private gardens on passers-by;

5. The external uneconomy of the producer to the producer, such as the pollution of the downstream fishing ground by the upstream chemical plant;

6. The external uneconomy of the producer to the consumer, such as the impact of construction on the residents who rest at night;

7. Consumers' external uneconomy to producers, such as the impact of air conditioning noise on the dentist next door;

8. Consumers are not economical to the outside of consumers, such as the neighbors next door singing loudly and affecting their rest.

In actual economic activities, due to the existence of externalities, the efficiency of resource allocation within the market scope is reduced, which directly leads to market failure. The externality theory belongs to the concept of modern Western economics, mainly for the problem of modern environmental pollution, specifically refers to the manufacturer polluting the surrounding environment of the factory, which is equivalent to occupying a certain amount of environmental resources, but in fact, the manufacturer will not pay any fees or compensation.

Externality, also known as externality or external influence, is a term used in economics and public administration, specifically referring to situations in which the actions and decisions of one person or a group of people will damage or benefit another person or group of people. In other words, the consequences of an organization or individual are not only borne by themselves, but also by others. Generally, according to the different ways of internal differentiation of costs and benefits, externalities can be divided into negative externalities and positive externalities.

From an economic point of view, the concept of externalities was developed by the Western economists Sher and Pigou in the early 20th century, specifically in relation to the problem of environmental pollution in factories.