2.8 Market failure - externalities, common pool resources, public goods, asymmetric information

The transaction is between the honey farmer (seller) and honey buyers (buyers). The orchard owner is not a party to this exchange — they did not buy or sell anything related to the honey market.

An externality is a spillover effect on a third party outside the original transaction. The orchard owner is exactly this: a third party who receives a benefit (better pollination) without paying for it.

Because the orchard owner gains from the honey farmer's production activity without compensating the farmer, this is an external benefit — specifically a positive externality of production from the honey farmer's side, and an external benefit received by the orchard owner as third party.

The answer is that the orchard enjoys an external benefit received by a third party. The other options incorrectly label costs (no cost is imposed on the orchard), misattribute the benefit to the farmer's private calculation, or introduce irrelevant information asymmetry.

The question asks how to describe the orchard owner's position — do they experience an external cost, an external benefit, a private benefit, or an information problem?

'A negative externality of production, because the bees impose costs on the orchard' is wrong. The bees help the orchard by pollinating it — this is a benefit, not a cost, to the orchard.

'A private benefit to the honey farmer' is wrong because private benefit refers to what the farmer personally gains from producing honey (e.g. revenue). The pollination benefit goes to the orchard owner, not the farmer.

'A case of asymmetric information' is wrong because asymmetric information requires one party in a transaction to have more knowledge than the other. The orchard owner not knowing about bees beforehand does not make this an information asymmetry — no transaction between the orchard owner and farmer existed.

The only remaining option — an external benefit received by a third party — correctly captures the spillover: the orchard owner gains from the honey-producing activity without being part of that transaction.

Marginal Private Benefit (MPB) = $50(thehousehol{d}^{\prime }sownenjoyment).\ast \ast MarginalExternalBenefit(MEB)\ast \ast =$30 (neighbours' enjoyment — third parties who did not purchase the fireworks).

$MSB=MPB+MEB=\$50+\$30=\$80$

The market will only reflect the household's MPB of $50whendecidingwhethertopurchasethedisplay.Because$MSB = $80 > MPB = $50$,thegoodisunderconsumed—notenoughdisplaysarepurchased—sincethemarketignoresthe$30 benefit to neighbours.

**$80\ast \ast istheMSB,capturingthetotalbenefittosociety.Optionslisting$50 or $30 alone capture only one component, while subtracting makes no economic sense.

The question asks for marginal social benefit, which must include benefits to all members of society, not only the buyer.

'$50 because MSB only counts what the buyer is willing to pay' is incorrect — that definition describes MPB, not MSB. MSB explicitly includes external benefits to third parties.

'$30becauseMSBonlycountsthebenefittopeopleoutsidethetransactio{n}^{\prime }iswrong—$30 is only the external benefit. MSB is the sum of private and external benefits.

'$20 because MSB subtracts the external benefit' is incorrect. External benefits are added to private benefits in the MSB formula, not subtracted.

**$80\ast \ast iscorrect:$MSB = MPB + MEB = $50 + $30 = $80$. This is the only option that correctly applies the social benefit identity.