Question

How does the marginal-cost marginal-benefit rule apply to avoid demand-side and supply-side market failures?

Answer 1

The marginal benefit - marginal cost rule tells us which plan provides the maximum excess of total benefits over total cost, or the plan that provides the society with maximum amount of net benefits. In order to overcome the demand side and supply side market failure problem in cost benefit analysis, the marginal cost to the society is raised by the amount of the social cost in case of negative externality. On the other hand, in case of positive externality, the social benefit is depicted by raising the amount of the marginal benefit by the social benefit. In this way we can incorporate market failures in marginal cost and marginal benefit analysis.