Lesson - 2.10.1
In a free market, the price mechanism determines the most efficient allocation of scarce resources in response to the competing wants and needs in the marketplace
Scarce resources are the factors of production (land, labor, capital, enterprise)
Free markets often work very well
However, there is sometimes a less than optimum allocation of resources from the point of view of society. This is called Market Failure
Sometimes there is an over-provision of goods/services which are harmful (demerit goods) & therefore an over-allocation of the resources (factors of production) used to make these goods/services e.g. cigarettes
Sometimes there is an under-provision of the goods/services which are beneficial (public goods & merit goods) & therefore an under-allocation of the resources (factors of production) used to make these goods/services e.g. schools
Sometimes the market causes a lack of equity (inequality) - the rich get richer and the poor get relatively poorer
Sometimes, environmental damage occurs during the production or consumption of a good/service
In each of these cases, from society’s point of view there is a lack of efficiency in the allocation of resources
Private, Social & External Benefits
External benefits occur when the social benefits of an economic transaction are greater than the private benefits
A private benefit for a consumer, producer or government is what they actually gain from producing or consuming a good/service e.g. a bee farm gains the private benefit of the income from selling their honey
An external benefit (positive externality) is the benefit not factored in to the market transaction e.g. The bees from the bee farm pollinate the nearby apple orchards
The social benefit includes both the private benefit & the external benefit to society
It is a better reflection of the true benefit of an economic transaction
Social benefit = private benefit + external benefit