Understanding market failure: Externalities of consumption and monopoly power

Overview

Why external benefits and costs of consumption leave the market at the wrong quantity, and how monopoly power restricts output, raises price and cuts consumer surplus.

What you need to know

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Questions from this subtopic

Each one with the model answer underneath.

1. 1

   With external benefits of consumption, why is private benefit less than social benefit?

   Model answer

   Because consumers do not consider the positive spillover effects their consumption creates for third parties.

2. 2

   With external benefits of consumption, how does market equilibrium quantity compare to the socially optimal quantity?

   Model answer

   The market equilibrium quantity is below the socially optimal quantity.

3. 3

   What is the welfare consequence of external benefits of consumption?

   Model answer

   Welfare loss results from under-consumption.

4. 4

   With external costs of consumption, why does private benefit exceed social benefit?

   Model answer

   Because consumers do not bear the external costs their consumption imposes on third parties, so their perceived benefit overstates the true benefit to society.

5. 5

   What is the welfare consequence of external costs of consumption?

   Model answer

   Welfare loss results from over-consumption.

6. 6

   Why is monopoly power a form of market failure?

   Model answer

   Monopoly power causes market failure because monopolists restrict output and raise prices above competitive levels, creating deadweight welfare loss.

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