Hanley, Shogren, and White (2007) states that "A market failure occurs when the market does not allocate scarce resources to generate the greatest social welfare. A wedge exists between what a private person does given market prices and what society might want him or her to do to protect the environment. Such a wedge implies wastefulness or economic inefficiency; resources can be reallocated to make at least one person better off without making anyone else worse off."

I understand the basic idea that the private and social costs are different, and therefore, there is economic inefficiency. However, the last sentece confuses me, "resources can be reallocated to make at least one person better off without making anyone else worse off". How is this the case? Won't producers be made worse off? And which group is being made better off, and why?

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    $\begingroup$ It is the very definition of the failure of efficiency that a person can be made better off without hurting any other person. $\endgroup$ Apr 9, 2020 at 23:42
  • $\begingroup$ Thanks, but when we change our quantity to E1, isn't there a loss of economic efficiency, which will make people worse off? $\endgroup$ Apr 9, 2020 at 23:51
  • $\begingroup$ I don't think that is the proposed change, note that your quoted text does not claim so. $\endgroup$
    – Giskard
    Apr 10, 2020 at 5:50
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    $\begingroup$ @ChristopherU no there isn’t because the social cost curve is the true economic cost. If there is no externality the social cost curve and private cost curve overlap. However, if they are different then there will be an economic inefficiency. By pushing private cost to again overlap with social costs we are correcting the source of economic inefficiency not creating any new inefficiency. $\endgroup$
    – 1muflon1
    Apr 10, 2020 at 11:40
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    $\begingroup$ @ChristopherU yes $\endgroup$
    – 1muflon1
    Apr 11, 2020 at 0:12

1 Answer 1


The 3 types of market failures are:

  1. Externalities
  2. Anti-competitive markets
  3. Suboptimal initial resource allocation

This statement to me is talking about point 3. When resources are initially distributed unequally (as they of course are in real life), the second fundamental theorem of welfare economics shows that "lump-sum transfers" can improve total societal utility from a utilitarian point of view.

However, this doesn't work the same way for the other two types of market failures. For externalities, you make one person (the producer of the externality) worse off, but it makes the whole system better off to a greater degree.

With anti-competitive markets that have deadweight losses (which are generally corrected for by discriminatory pricing), unintuitively subsidizing the monopoly will lead to more optimal pricing. This leaves everyone better off - customers get a cheaper price, more customers can afford the product, and the monopoly makes more money. This is rarely actually fronted as a real idea tho, because most people who want to do something about monopolies harbor some kind of resentment of them, and don't want to do anything that would benefit them.


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