CIMA BA1 Syllabus B. Microeconomic And Organisational Context Of Business - Market failure - externalities - Notes 5 / 9
Market failure - externalities
Externalities
A positive or negative impact of a transaction on people who are external to that transaction (ie not a buyer or seller).
Positive and negative externalities
Positive externalities
Benefits from production or consumption of a good or service that extend beyond the trading parties (ie the buyer and seller)
Negative externalities
Costs from production or consumption of a good or service that extend beyond those paid for by the trading parties
Merit and demerit goods
Sometimes a product generates such a high impact in terms of externalities that it is generally agreed that this product is either good or bad for society as a whole.
Merit good
Generates positive externalities to society as a whole (social benefits).
For example, vaccinations, education
Demerit good
Generates negative externalities to society as a whole (social costs).
For example, smoking.
Dealing with externalities
| Merit goods | Demerit goods |
|---|---|
| Subsidies to reduce the price. | Indirect taxation to raise price. |
| Public information campaign to stress benefits. | Public information campaign to raise awareness of risks. |
| Public provision of the product. | Legislation/ ban on product, eg smoking in public buildings. |
| Price regulation (maximum price). | Price regulation (minimum price). |
Public goods
Public goods have two characteristics:
Non-diminishability
-the good or service can serve a small or large number of people at exactly the same cost
E.g. the good or service does not diminish in supply as more people enjoy it.
Non-exclusivity
- providers of the good or service cannot exclude non-payers, which makes it unlikely that it will be provided by profit-seeking providers.
Note that not all goods provided by the public sector are public goods,
e.g.
healthcare is a merit good, not a public good, because it is diminishable (ie there is less healthcare available for others as more people use healthcare resources).