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A type of market failure that occurs is the presence of externalities.
Externalities are third party (spillover) effects that affect those who are not involved in the production and/or consumption of the good themselves.
Types of externalities:
- Negative externalities – there is overproduction/overconsumption of the good
- Positive externalities – there is underproduction/underconsumption of the good.

When externalities arise, governments are expected to intervene in order to eliminate the market failure and move towards the optimal allocation of resources

For example:
Negative externalities of production occur when the production of goods creates external costs that are damaging to third parties.

-Producers produce where MPB=MPC, at quantity Q
- However, the socially desirable level of output is at MSC=MPC at quantity Q1
- From the diagram, MSC > MPC, which shows that there is negative externalities.
- This is considered a market failure because there is misallocation of resources - too much resources are devoted to produce the good.
- The deadweight loss is area ABC.

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How do governments intervene when there is negative externalities of production?

- Taxation: the government will tax the good until it reaches the socially desirable level of output
- Setting rules and regulations: control the level of emissions
- Pollution permits: to limit the amount of pollution

On the other hand, when a good generates postive externalities of production, it means that there is under production of the good

The goverment can intervene by giving subsidies

- The government will subsidize the good up to the socially desirable level of output

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-Government intervention - any action carried out by the government that affects the market economy with the direct objective of having an impact in the economy.
-government intervention can be in the form of direct intervention or subsidy.

Economic efficiency - define
Two parts of economics efficiency:
Allocative efficiency (define)
Productive efficiency (define)

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However, government intervention may not be effective:

Taxation:
- It may not be effective if the goods produced are inelastic in demand as producers can pass on the high costs onto consumers.

- Difficult to place a monetary value on negative externalities

Subsidies:
- May not be effective in the long run as other projects may be put on hold by the government

-  Being protected by government will cause producers to be dependent upon them. Therefore, producers will not find efficient methods of production

- Pollution permits: may not be able to reduce pollution in a particular area

Direct Provision:
- The good may not be of good quality

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Define - one firm in the industry
Characteristics - 1 seller many buyer, price maker
Diagram -

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Lowering barriers to entry for monopoly:
firms who get subsidized may not want to do RnD but rather keep the money to themselves as  profits

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Problems of information:
Government might have inaccurate information and as a result lead to greater economic efficiency.
E.g. consumers demand 1000 units of goods then government supplies 1000units of goods. However only 800units are consumed therefore there is an inefficiency of 200units (lack of information)

Problems of incentives:
Direct tax:
Distort incentives to work harder. Scare resources are not put to best use thus Inefficiency occur

Indirect tax: disincentive for consumers and producers created by the tax led to the wrong amount of goods being produces

Problems of distribution:
Government intervention might increase greater inequity instead if reducing.
E.g. imposing tax will affect the low income earners more than the high income earners

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For allocative efficiency, in the micro view.
Monopolist always produce at profit maximization point where MC = MR. Clearly from this we can see that they are producing at P>MC and there is deadweight loss at area ABC thus we can say that monopolist are not economically efficient.

In order for the monopoly to be allocatively efficient, they must produce at the socially desirable level of output where P=MC at Q1 and P1.

The question is how can government intervention improve efficiency?

1) lowering barriers to entry by having govt to subsidize other firms. This will make the firms to compete by increasing quantity and lowering price
2) monitoring of monopolist who practise anti-competitive practice
3) government can use max price to prevent from dragging too high prices and exploit consumers

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For productive efficiency, in the micro view.
Since monopolist produce at MC=MR, monopoly firms will not achieve productive efficiency as firms will produce at an output which is less than the output of min AC. X-inefficiency may occur since there is no competitive pressure to produce at the minimum possible curve. Thus monopolist is productively inefficient because they are not producing at the lowest AC curve
(refer diagram where PE is)

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Additionally,

Public goods are goods that benefit the society however, it would not be provided in a free market.

Hence, no provision of public goods in a free morket is a type of market failure.

Public goods are not provided because they are:

- Non rival: consumption by one person does not reduce the consumption for others

- Non excludable: Once it is provided, it is impossible to stop others from consuming it

This leads to "free rider" problem where a person can benefit from consuming a good without paying for it

So in a free market, firms will not be able to make profit by supplying public goods.

The government may intervene and solve this market failure by:

- Direct provision: providing the good themselves

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In conclusion, when government intervenes in market failure, it will improve efficiency however only up to a certain extent. It can also lead to inefficiency due to problems mentioned above.

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Intro:
Define PE & AE (both in micro and macro point of view and draw diagrams)
Explaining EE (both PE and AE needs to exists)
Explain on dynamic efficiency
Explain pareto optimality (this can be joined with the PPC diagram as you explain PE)

Content:
Discuss on market failure
- monopoly with diagram
- externalities (no need diagram as diagram will be explained under the definition part of AE)
- no public goods
- too much demerit goods
- too little merit goods
-asymmetric info
(explain and elaborate all of the above)
(explain why it does not achieve efficiency)

Govt intervention
- monopoly (regulation, prevent mergers, acquisition, encourage more private firms)
- externalities (taxes, pollution permit, subsidies, etc)
- no public goods (direct provision)
- too much demerit goods (ban, taxes, fines)
- too little merit goods (subsidies)
- asymmetric info (impose laws, get the right info to be informed to public)

Govt intervene - is it effective? (Refer to notes on effectiveness of govt intervention)

Conslude.