(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 651

626 PART 4 • Information, Market Failure, and the Role of Government
may prevent some markets from ever developing. It may, for example, be impossible to purchase certain kinds of insurance because suppliers of insurance lack
adequate information about consumers likely to be at risk.
Each of these informational problems can lead to competitive market inefficiency. We will describe informational inefficiencies in detail in Chapter 17 and
see whether government intervention might help to reduce them.

Externalities
The price system works efficiently because market prices convey information
to both producers and consumers. Sometimes, however, market prices do not
reflect the activities of either producers or consumers. There is an externality
when a consumption or production activity has an indirect effect on other consumption or production activities that is not reflected directly in market prices.
As we explained in Section 9.2 (page 323), the word externality is used because
the effects on others (whether benefits or costs) are external to the market.
Suppose, for example, that a steel plant dumps effluent in a river, thus making a recreation site downstream unsuitable for swimming or fishing. There is an
externality because the steel producer does not bear the true cost of wastewater
and so uses too much wastewater to produce its steel. This externality causes an
input inefficiency. If this externality prevails throughout the industry, the price
of steel (which is equal to the marginal cost of production) will be lower than if
the cost of production reflected the effluent cost. As a result, too much steel will
be produced, and there will be an output inefficiency.
We will discuss externalities and ways to deal with them in Chapter 18.

Public Goods
• public good Nonexclusive,
nonrival good that can be made
available cheaply but which,
once available, is difficult to
prevent others from consuming.

The last source of market failure arises when the market fails to supply goods that
many consumers value. A public good can be made available cheaply to many

consumers, but once it is provided to some consumers, it is very difficult to prevent
others from consuming it. For example, suppose a firm is considering whether to
undertake research on a new technology for which it cannot obtain a patent. Once
the invention is made public, others can duplicate it. As long as it is difficult to
exclude other firms from selling the product, the research will be unprofitable.
Markets therefore undersupply public goods. We will see in Chapter 18 that
government can sometimes resolve this problem either by supplying a good
itself or by altering the incentives for private firms to produce it.

E XA MPLE 16.5 INEFFICIENCY IN THE HEALTH CARE SYSTEM
The United States spends a larger fraction of its
GDP on health care than do most other countries.
Does this mean that the U.S. health care system is
less “efficient” than other health care systems? This
is an important public policy question that we can
clarify by taking advantage of the analysis presented
in this chapter. There are two distinct efficiency issues
here. First, is the U.S. health care system technically

efficient in production, in the sense of utilizing the
best combination of such inputs as hospital beds,
physicians, nurses, and drugs to obtain better health
outcomes? Second, is the United States output
efficient in the provision of health care; that is, are
the health benefits from the marginal dollar spent on
health care greater than the opportunity cost of other
goods and services that might be provided instead?