Market Failure from Differentiated Product Pricing as an External Effect
The market failure that occurs when a producer of a differentiated good prices above marginal cost can be understood as a consequence of an external effect. The producer's pricing decision negatively impacts potential consumers who are willing to pay more than the marginal cost but are excluded from the market. This effect is 'external' because the producer does not account for the lost surplus of these consumers when setting the price. This situation is analogous to other market failures, such as pollution, where a decision-maker ignores costs imposed on third parties.
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Introduction to Microeconomics Course
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