We have learned in the previous lesson that it is inevitable for the market to fail which then

necessitates appropriate government intervention. One market failure has also been identified which
is imperfect competition. However, there are other types of market failure that you yourself might
have encountered.

In this lesson, we are going to study other types of market failures specifically externalities
and public goods.
Suggested Time: 2 mins | Actual Time Spent: ____min(s)

Have you ever been affected, either positively or negatively, by a decision of an individual or
group of people but did not pay for the benefits nor get compensation from them? Take this situation
as an example. Say you are seated in between two persons: Person A who talks softly and Person B
who talks loudly. Whenever you hear their voices, you do not get compensation for Person B’s loud
voice as it causes discomfort on you. However, you do not also pay for the soft and pleasant voice
you hear from Person A. These types of third party or spillover effects are referred to as externalities.

As stated by Samuelson and Nordhaus (2010) “Externalities (or spillover effects) occur when
firms or people impose costs or benefits on others outside the marketplace.” Externalities can be
positive or negative. Positive externalities are those transactions or activities made by other people,
but you benefit from it without paying for them. Good music, beautiful scenery from a garden, and
new discoveries and inventions from research and design (R&D) of a company that increases the
general welfare of the people are some other examples of positive externalities. On the other hand,
negative externalities are those transactions or activities made by other people, but you are made
worse off because of these activities without you getting paid or compensated. Person B’s loud voice,
poultry and pig farm odor, and smog from businesses and factories are the examples of negative
externalities.

PSHS Social Science 5: Economics | Page 1 of 3

 People’s transactions, either with positive or negative externalities, are not compensated since
there is no marketplace for them (i.e. no market for pollution). These transactions or activities may
include those that result to environmental degradation or pollution. With these scenarios in mind, the
government intervenes and tries to control the effects of externalities. One example is the imposition
of taxes or penalties to individuals, firms, and industries that spill or dump wastes in land or in bodies
of water (e.g. Ecological Solid Waste Management Act of 2000).

As mentioned above, transactions or activities that bring negative externalities call for
government action through regulation. However, it is also important to acknowledge transactions or
activities that bring positive externalities because of its contribution to the economy. One type of good
that illustrates characteristics of positive externality is the public good.

Have you ever noticed the benefits brought by public parks, or light posts on the road while
you are travelling especially at night, and the peace and order brought by national defense? These are
some examples of public goods. Public goods are commodities that can be enjoyed by everyone and
no one can be excluded from consuming it (Samuelson and Nordhaus, 2010). Since no marketplace
or private entity would be willing to provide this type of goods, public goods are provided by the
government usually through taxation.

Given that public goods are non-excludable and are made available to all members of the
society, it may lead to free rider problem. This is observed when an individual or group of individuals
enjoy the benefits brought by the public good but are not willing to pay for it. It may also occur when
they just pay a small contribution relative to their overall benefit. If free rider problem happens, in a
free market, there is a tendency that goods will be under provided.

An example of public good that can be susceptible to free rider problem is air pollution control.
If only a few people would pay for the cost of cleaning the air, other people cannot be excluded in
inhaling clean air. Given this, the government tries to reduce the occurrence or the effects brought by
free rider problem through efficient tax system.

With the abovementioned market failures, government intervention is necessary for the
economy to be efficient, equitable, and stable. The government takes actions either through regulatory
taxes for externalities or by providing the public goods that will benefit the members of the society.

Suggested Time: 10 min | Actual Time Spent: ____min(s)

PSHS Social Science 5: Economics | Page 2 of 3

References:

Official Gazette of the Philippines. (2001). Republic Act No. 9003. Retrieved from
https://www.officialgazette.gov.ph/2001/01/26/republic-act-no-9003-s-2001/

Samuelson, P. A. & Nordhaus, W. D. (2010). Economics (19th ed.). New York: McGraw-Hill
Education.

Prepared by: Nneka B. Evangelista Reviewed by: Pauline Kirstie H. Atumpag

Position: Special Science Teacher 1 Position: Special Science Teacher
Campus: PSHS CALABARZON Campus: PSHS - CLC

PSHS Social Science 5: Economics | Page 3 of 3