Page 358 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Unit-23: Market Failure: Meaning and Sources

apple orchid does not include this profit in its marginal profit. In decision of his level of production, Notes
he only equalizes the marginal cost to his marginal benefit and does not bother about the external
marginal profit of the bee farmer. Then on the basis of positive externality, which is socially expected,
the minimum level of production will identify. This is represented by Fig. 23.5.

Fig. 23.5

Y

MB
S MC
MB
P
Marginal
External
Price P 1 0 Benefit
P

Marginal Under
Benefit Production
O X
Q Q*
0
Quantity

In Fig. 23.5, the productive quantity of apple displayed on axis OX, while axis OY indicates the price.
The production of OQ units of apple occur on OP price, so the marginal private profit is equal to
0
0
marginal cost. When outer profit is included then MB becomes MB and thus, after internalization of
P
S
externality the production of apples should be increased from OQ to OQ*. Thus the result is that total
0
output is less than the socially optimal output in case of positive externality.

Give your opinion on Excludable Goods and Market Failure.

23.8 Externalities and the Coase Theory
Due to externalities, the above described problems can solve by one more method and that is the person
who was responsible for this externalities should give property rights. This thinking is the base of Coase
Theory. To develop the Coase Theory, credit goes to famous British economist Ronal Coase who gets
the Nobel Prize of economics in 1991. According to Coase Theory, “If two factors of an externality–one
who is responsible for it and the other who is affected from it can agree on an agreement that they will
produce the perfect production by factors.” When a product’s property right is described with clarity
then an agreement can sign between beneficiary and victim and then the optimum social production of
that product can occur.
For example, two students A and B live in a room. A smokes, but B doesn’t. Student A always
smokes while reading which results bad effect on B’s health. Since the air in room is collective
property of both the students, so the student B cannot force student A to stop the smoking. But if
the property right of air of that room can be given to one of them then, an optimum satisfaction
level can be obtained from both of the students A and B. First, if property right can give to
student A, then he can say to student B that to low the smoke of cigarette in air he will pay

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