We discussed four types of market failures in class. List two types of market failures, give...

We discussed four types of market failures in class. List two types of market failures, give an example of market or type of product for which this failure is likely to exist, give an example of a solution, and state whether it is an incentive compatible approach or a command-and-control approach.

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Expert Solution

Market failure is a situation in which there is inefficient allocation of goods and services in a free market situation. There are many types of market failure, but most important among them are-

Externalities - It means the positive or negative effect of the economic activities performed by one person on the other person. If the economic activities of one person does some good for other for which he/she doesn't have to pay then it is an example of positive externalities. And if the activity of one person has some bad effect on other for which he/she is not paid then it is the case of Negative externalities. An example of an externality may be the pollution caused by a factory in its nearby areas. This pollution effects the health of people living around the factory and they incurr cost of treatment because of others but they have to pay themselves, this causes externality. The solution to this externality may be to put a fine on the factory to compensate the people, and this is an example of command-and-control approach.
Public goods- Public goods are those goods which are mostly provided by the government free of cost but the main characteristics of a public good is the Non- excludable and Non-rivelary. This creates market failure because public goods are provided by the money which are collected through taxes but the non excludability characteristics of the public good allows everyone to use it even those who do not pay for it. An example for this type may be a tree planted by someone but the fruits and oxygen which is given by tree can be used by any one because it possesses the characteristics of non-excludability because you can't stop someone to breath near your tree. But to compensate the person who planted the tree government can provide financial support to plant more trees or maintain it, this will be an example of incentive compatible approach.

Rahul Sunny answered 2 weeks ago

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