Market Failure
total surplus (both of the consumer and
producer) is maximized in free markets.
The market equilibrium price and quantity are socially optimal…
(1) when all relevant production costs are incurred by sellers
(2) when all relevant consumption benefits accrue to buyers.
Sometimes costs or benefits that result from an activity accrue to people not directly involved in the activity
Ex ternal cost = a cost paid by people other than the
consumer or the producer trading in the market
Social cost = the cost to everyone
o Social cost = private cost + external cost
Deadw eight Loss is the welfare loss because of
quantity traded deviating from social optimal level