Unit 6 Notes: Externalities, Public Goods, and Market Failure in AP Microeconomics

Socially efficient outcome

An outcome that produces the quantity of a good/service that maximizes total surplus (total net benefits) for society.

Total surplus

The sum of consumer surplus and producer surplus; a measure of total net benefits created in a market.

Marginal private benefit (MPB)

The additional benefit received by the direct consumer from consuming one more unit of a good.

Marginal private cost (MPC)

The additional cost paid by the direct producer to produce one more unit of a good.

Marginal social benefit (MSB)

The additional total benefit to society from one more unit; equals MPB plus any marginal external benefit (MEB).

Marginal social cost (MSC)

The additional total cost to society from one more unit; equals MPC plus any marginal external cost (MEC).

Socially optimal quantity

The output level where MSB = MSC (the efficiency condition for the best quantity from society’s perspective).

Deadweight loss (DWL)

Lost total surplus that occurs when the market quantity differs from the socially optimal quantity; typically shown as a triangle between MSB and MSC over the misallocated units.

Market failure

When an unregulated market does not allocate resources efficiently (i.e., it does not produce the socially efficient quantity).

Externality

A spillover effect of a market activity that affects a third party not included in the buying/selling decision, causing private and social costs/benefits to differ.

Marginal external cost (MEC)

The additional cost imposed on third parties when one more unit is produced/consumed; MSC = MPC + MEC.

Marginal external benefit (MEB)

The additional benefit received by third parties when one more unit is produced/consumed; MSB = MPB + MEB.

Negative externality

An externality that imposes costs on third parties (e.g., pollution), often causing the market to overproduce relative to the social optimum.

Positive externality

An externality that creates benefits for third parties (e.g., education, vaccines), often causing the market to underproduce relative to the social optimum.

Pigouvian (corrective) tax

A per-unit tax set equal to the marginal external cost (at the socially optimal quantity) to internalize a negative externality and reduce output toward efficiency.

Tradable pollution permits (cap-and-trade)

A system where the government caps total pollution and issues permits that firms can buy/sell, helping achieve the cap at lower total cost through trading.

Subsidy (correcting a positive externality)

A per-unit payment that encourages more consumption/production, aiming to move the market quantity toward the socially optimal level when there are spillover benefits.

Rivalry

A property of a good where one person’s consumption reduces the amount available for others.

Excludability

A property of a good where producers can prevent nonpayers from consuming it.

Private good

A good that is rival and excludable (e.g., a seat on an airplane); competitive markets tend to allocate these relatively efficiently.

Public good

A good that is nonrival and nonexcludable (e.g., national defense); private markets tend to underprovide it due to free riding.

Common resource (common-pool resource)

A good that is rival but nonexcludable (e.g., open-access fisheries); tends to be overused because users capture private benefits while sharing costs.

Club good

A good that is excludable but nonrival (at least until congestion), such as streaming services or toll roads when uncongested.

Free-rider problem

When people benefit from a good without paying because it is nonexcludable, leading to underprovision (especially for public goods).

Tragedy of the commons

Overuse of a common resource because individuals ignore the full social cost of their actions in an open-access, rival, nonexcludable setting.