Key Terms of Semester Two IB HL Economics

1. Semester Two Definitions Section 2,

2. Market Failure occurs when the price mechanism results in an inefficient or grossly unfair allocation of resources. There are various types of market failure. One type is goods that are not produced or are under or over produced in a market system. These are respectively called public goods, merit goods and demerit goods. Another type of market failure is the existence of externalities – external costs or benefits resulting from consumption or production. Market Failure

3. Merit goods are products, such as education, which consumers may undervalue but which the government believes are ‘good’ for consumers as they exhibit positive externalities. Merit goods would be therefore be underprovided in a pure free-market economy. People do not take account of positive externalities when they decide how much to consume of a good so they may therefore under-consumer the good. Merit Goods

4. Public goods are goods that would not be provided in a pure free-market system. This is because they display the characteristics of non-rivalry and non excludability. Non-rivalry means that consumption by one person does not reduce the amount available for another (eg. Street lighting) and non-excludability means that once the good is provided it is not possible to stop people benefiting from it (eg. Lighthouses). Public Goods

5. Positive externalities are spillover effects on ‘outsiders’ (people not involved in the production or consumption of the good/service) that are advantageous to them and for which they do not have to pay. In the case of positive externalities the external benefit is added to the private benefit to give the total social benefit. An example of a positive externality might be a firm offering advanced driver training for their employees. The firm may do it for private benefit (reduced insurance and accident costs) but this will also have a spillover effect for society in improving safety generally on the roads. Positive Externality

6. Negative externalities are spillover effects that have an impact on ‘outsiders’ (people not involved in the production or consumption of the good/service) that are disadvantageous to them and for which they receive no compensation. Examples of negative externalities may include effects like pollution and the effects of secondary smoking. Negative Externality

7. The marginal private benefit (MPB) is the increase in private benefit resulting from the consumption of one more unit or the production of one more unit. The private benefit is the benefit to the individual of a particular purchase or action. For example, if an individual receives a vaccination against smallpox, their private benefit will be the value of the vaccination to them. The private benefit does not include other social benefits like the vaccination also helping to protect others in society as well. Marginal Private Benefit

8. The marginal private cost (MPC) is the cost incurred by just the firm or the consumer in producing or consuming each extra unit of a good. It is the marginal cost of production or consumption. For example, the marginal private cost of driving a car a mile will simply be the cost of the fuel necessary to drive that distance. Marginal Private Cost

9. The marginal social benefit (MSB) is the change in private benefit and any positive externalities resulting from the consumption of one more unit. For example, if an individual receives a vaccination against smallpox, their private benefit will be the value of the vaccination to them. However, as a result of the individual receiving that vaccination, others in society will also be protected against the disease. This is a benefit to society or social benefit. Individuals or firms will not generally be concerned about these social benefits when making their consumption or production decisions. Marginal Social Benefit

10. The marginal social cost (MSC) is the cost incurred by both the firm/consumer and society in producing or consuming each extra unit of a good. It will include the marginal private costs and any extra external costs that may have arisen from production or consumption. For example, marginal social cost of driving a car a mile will simply be the cost of the fuel necessary to drive that distance. There will, however, be additional negative externalities (external costs) like the additional carbon emissions, noise and so on. Marginal Social Cost