A-Level Why Markets Fail

Producing farmed poultry meat generates negative externalities of production: external costs borne by third parties not involved in the transaction, such as water/land pollution from waste run-off, greenhouse-gas emissions, disease and antibiotic-resistance risks. Because of these spillover costs, marginal social cost exceeds marginal private cost: MSC = MPC + marginal external cost (MEC), so the MSC curve lies above the MPC curve. Diagram (describe): quantity on the x-axis, price/cost on the y-axis. Draw the demand curve D = MPB = MSB (assume no consumption externality). Draw MPC (supply) and, above it, MSC parallel and higher by MEC. The free market produces where MPC = MPB, giving output Qm at price Pm. The socially optimal output is where MSC = MSB, at Qs, which is lower (Qs < Qm). Over the range Qs to Qm, MSC > MSB, so each of these units adds more to social cost than to social benefit. The market over-produces poultry meat relative to the social optimum; this over-allocation of resources is a welfare loss, shown by the shaded deadweight-loss triangle between the MSC and MPB curves from Qs to Qm. This divergence between private and social costs, causing over-production and a deadweight welfare loss, is market failure.

A negative externality is a cost imposed on a third party who is not part of the market transaction and which is not reflected in the market price, so that the marginal social cost exceeds the marginal private cost (MSC > MPC). In the airline industry, when an airline operates flights, its private costs are fuel, crew and aircraft, but the flights also emit greenhouse gases (CO2) that contribute to climate change and generate noise pollution affecting communities near airports and flight paths. These costs fall on society/third parties rather than on the airline or its passengers, so the price of a ticket understates the true cost to society and air travel is over-consumed/over-produced relative to the socially optimal level.

Two distinct forms of market failure associated with Bitcoin, using typical case-study extract material: 1) NEGATIVE EXTERNALITY IN PRODUCTION (environmental). Bitcoin is created by 'mining', which consumes enormous amounts of electricity (the extracts note energy use comparable to a whole country). This generates carbon emissions and pollution borne by third parties not involved in the transaction. The marginal social cost of mining therefore exceeds the marginal private cost (MSC > MPC). Because miners ignore this external cost, the activity is over-produced relative to the socially optimum level, creating a deadweight welfare loss. 2) IMPERFECT/ASYMMETRIC INFORMATION (information failure). The extracts point to extreme price volatility, speculation, scams and the difficulty ordinary buyers face in valuing Bitcoin. Buyers and sellers do not have full or equal information about its true value or risks, so they mis-allocate resources, over-invest during bubbles and are exposed to fraud. This information failure means the market outcome is not allocatively efficient. (An acceptable alternative second form is the negative externality from Bitcoin's use in illegal transactions / crime.) Each form should be named, explained with a link to the extract, and tied to why it prevents an efficient (socially optimal) allocation of resources.