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Market Failure Concepts Refresh

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Market Failure Concepts Refresh

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Refer to the Understanding Market Failure read and educational video to answer the question.


Q1). In the WHO example of passive smoking, what type of externality if passive smoking?

  • As a public policy analyst, what would you recommend the federal government to do?


Q2). Public goods are __________ and ____________


Q3). If the marginal benefit > marginal cost, the government must _____________ the public good project.


Q4). SAAS based products or platforms are a type of non rival but excludable products. Explain.


Q5).  A small country wants to limit the traffic on roads. It builds a world class infrastructure and wants to nudge its citizens to use public transport. As a kick ass public policy specialist, what will be the recommendations. Refer to the tutorial on Market Failure here.


Q6). Refer to the following data to answer the questions. A manufacturer of a toy is selling the product to various customers in the market. Consider perfect competition, with marginal cost of manufacturing the toy is at 3.50. Answer the following questions based on the data shared.

Various Customers Customer willing to pay the price to buy the toy
A 3
B 4
C 4.5
D 3.5
E 4.25

a. Customer E buys the toy. Customer E has a consumer surplus or producer surplus? Calculate the surplus.

b. Find the same for customer A and D.

c. How will you interpret C willingness to pay 4.5 to B in terms of marginal benefit?

d. Now Top Gun is a new customer and feels the marginal benefit of the toy is the highest among all the listed five customers. What price range will Top Gun be willing to pay for the toy.



Q7).  For the side fig, at point B on the demand curve, the production is optimal?

At point B, what type of production would you see and why?



Q8). Look at the side figure. It shows the supply curve of cashewnuts in the market. Point E is the equilibrium, with price at 6 and quantity at 100 at this point. The minimum price required by the producers is 2. Using this information, calculate the producer surplus.

Hint the producer surplus is the difference between the equilibrium price and the minimum price required by the producers.

In this case, if 2 is the minimum price required by the producers, and assuming perfect competition, is it correct to say that 2 is the marginal cost of producing cashewnuts by all producers.



    1. Negative externality, Tax = Marginal External Cost                                                                                                                                                                               
    2. Non rival and non-excludable                                                                                                                                                                                                 
    3. Implement or subsidize                                                                                                                                                                                                                                         
    4. SAAS-driven internet products or platforms (software as a service) are usually paid and therefore excludable. Although non-rival, i.e. multiple users can use the service at the same time, these products can be accessed over devices example smartphones, tablets, laptops, or desktops. These devices cost money and are hence excludable. If accessed free example in a university, they are again part of an exclusive community.                                                                                                                                                                                                       
    5. Refer to the Singapore government initiative Vehicle Quota System (VQS). Refer to the read on Market Failure. Another measure could be an introduction of a toll on roads, taxing gasoline consumption making it cheaper to travel by public transport. Policies targeting climate change like taxing gasoline consumption (external negative externality is a good example).                                                       
    • a Consumer surplus as E is ready to more for the product. Consumer Surplus = 4.25 – 3.50 = 0.75
    • b. For Customer A there is no consumer surplus as a willingness to pay is less than the market price. The assumption here is that the producer will not sell the product for less than 3.5. For D, the consumer surplus is zero. D is paying at the equilibrium point e. the marginal benefit = marginal cost (MB = MC), point of perfect elasticity. 
    • c. Customer C is paying the maximum as C sees the highest marginal benefit for the product.
    • d. Since Top Gun has the highest marginal benefit from the toy among all the existing customers, Top Gun will be willing to pay the highest amount. The amount will be > 4.5, the highest price paid by customer C.                                                                                                                                                                                                                                                                                                                                                 
    • 7. The production is not optimal as the marginal benefit is less than the marginal cost. At point E, MB = MC. At point B, the customer’s willingness to pay is less than marginal cost point C. Hence, there will be an overproduction of the product as customer is not willing to pay the minimum product price required by the producer. Oversupply of the product leads to efficiency loss. 
    • (REFER MICROECONOMICS BY MCCONNELL, BRUE FLYNN )                                                                                                                                                                                                                                                                      
    • 8. The total revenue for the producers at price 6 is the area of the rectangle i.e. 100 * 6 = 600. i.e. the sum of blue triangle and red trapezoidal. The producer surplus is the blue triangle. The surplus is always from the minimum price required to the equilibrium price or the market price paid.  The area of the blue triangle is 100 * (6-2) = 100* 4 = 400                                                                               
    • Hint: for producer surplus use always the supply curve. For consumer surplus use the demand curve. 
    • True for a perfect competition, all firms/producers will have the same MC (marginal cost).        Producers will not sell less than MC as they will make a loss.


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