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Source: Economics for all p138

Externalities

 An externality occurs when some of the costs and benefits of a decision or action are borne or enjoyed by second or third parties that were not part of or directly involved in the decision making.

 Externalities are also called third party effects, side effects, spillover effects or neighbourhood effects.

 To understand externalities one has to understand four basic costs and benefit concepts: - Private costs – internal costs. The usual costs that consumers incur when they buy

goods, e.g. price of bicycle R990, but that includes costs of producing the bicycle like tyres, overheads, etc.

- Private benefits – internal benefits. Those benefits that accrue to those who buy the goods, and those who produce the goods.

- Social costs – this is the cost of goods or services to those who create them and the society at large. Private costs plus external cost are equal to social costs.

- Social benefits – positive externalities. For instance, municipalities provide clean water, for which consumers pay. Private benefits plus external benefits are equal to social benefits.

 Externalities are activities that exist if there is a difference between net social cost and net private costs.

 If net social costs exceed net private cost, than a negative externality is said to exist.  If the net social benefits exceed net private benefits, than a positive externality exits.  Negative externalities:

Source: Economics for all p139

o Pollution is an example of a negative externality.

o Another example of negative externality is the cost imposed on society by the use of motor cars. This includes air & noise pollution, accidents, congestion and damage to roads.

 Positive externalities:

Source: Economics for all p141

o A positive externality occurs when a benefit is derived by a second or third party from the action or decision of another party.

Public goods

 Definition of public goods, also called collective or social goods: goods and services which, if they are provided to all, are open to be used by all members of society.  Community goods – defense, police services, street lights, flood control, etc.  Collective goods – parks, beaches, streets, public transport, etc.

 Public goods have 2 features:

o Non-rivalry – this means that one person‘s enjoyment of goods does not reduce another person‘s enjoyment them, e.g. lighthouse.

o Non-excludable – people who are not willing to pay for goods cannot be excluded from enjoying them. They are known as free-riders. For example, TV and radio have many free-riders in SA.

 Free-rider: A problem intrinsic to public goods – because people can enjoy the benefits of public goods whether they pay for them or not, they are usually unwilling to pay for them.

 The provision of public goods is in the hands of government; the production of these goods might be done by firms in the private sector but this does not mean they are private goods.

 In SA, most goods and services in the economy are private goods. They have rivalry in consumption and excludability, e.g. if one learner consumes a chocolate, another is excluded from having it.

Merit and demerit goods

 Merit and demerit goods relate to desirability of use.

 Merit goods: beneficial goods to society that all individuals should be able to receive or consume, irrespective of their income (positive externalities).

 Demerit goods: goods such as drugs that may be socially harmful to society (negative externalities).

 Free market systems always under-produce merit goods; in addition government will provide them, even if it is only partly.

 Examples of merit goods are education, health care, etc.  Examples of demerit goods are cigarettes, alcohol, etc.

 Government can ban demerit goods or reduce consumption by means of taxation. Imperfect competition

 In market economies, competition is often impaired by power.

 Most businesses operate under conditions of imperfect competition that allows them to restrict output, raise prices and produce where price exceeds marginal costs.

Lack of information

 Information received or given to households and businesses may be incomplete, which can result in mistakes.

 In the presence of imperfect information, not all exchanges are efficient.  Advertisements can also play an important role in imperfect information.

 Another cause of market failure because of the lack of information, is asymmetric

information – a situation in which economic agents do not all have the same information. This is a common problem in the markets for second-hand goods, from houses to cars. Immobility of the factors of production

 Markets may not respond to changes in consumer demand if resources cannot move around easily.

 Resources are not very mobile at the best of times, so most markets do not adjust rapidly to changes in supply and demand.

 Labour may take time to move from one job or place to another, and the same with physical capital.

Imperfect distribution of income and wealth

 Free markets tend to generate an unequal distribution of income and wealth; free market systems reward certain participants better than others.

 This is caused by number of factors:

o A difference in market power

o The initial distribution of wealth

o Unequal access to markets and educational opportunities

o Discrimination