Quiz 5: Governments Role and Government Failure


Consumer surplus is the differences of the maximum prices consumers willing to pay and the lower market price. The table below shows the market data. img The total consumer surplus is the sum of all individual consumer surpluses. img The consumer surplus is negative because the new equilibrium price is too high to leave any surplus for consumers, while the highest willingness to pay stays unchanged.

A market failure happens in a particular market when the market produces an equilibrium level of output that either over allocates or under allocates resources to the product being traded in the market. The two causes for market failure are demand-side market failures and supply-side market failures. Demand-side market failures happen when demand curves do not reflect consumers' full willingness to pay for a good or service. It means that it is impossible in certain cases to charge consumers what they are willing to pay. Consider fireworks displays. Private firms will be unwilling to produce outdoor fireworks displays, as it will be nearly impossible for them to raise enough revenue to cover production costs. Demand-side market failures cause underproduction of a certain good. Supply-side market failures occur when supply curves do not reflect the full cost of producing a good or service. It means that a firm does not have to pay the full cost of producing its output. Consider a coal-burning power plant. It procures more electricity and generates more pollution than it would if it had to pay for the pollution. The extra units that are produced are units of output for which the costs are greater than the benefits; hence the overproduction problem. Supply-side market failures cause overproduction of a certain good. When market failure occurs, it either means underproduction or overproduction; thus, it is impossible for a market be affected by both types simultaneously.

Producer surplus is the differences between the actual price producers receive ($6) and the lower minimum payments they are willing to accept. The table below summarizes the market. img The market total producer surplus is the sum of all individual producer surpluses. img