Market failure

Market failure

Where markets fail to optimally allocate resources or where markets are missing or only partially

Ways which markets fail

1. When they are inefficient

2. When they are inequitable

Types of market failure

1. Missing markets

2. Information Failure

3. Factor immobility

4. Unstable commodities market

5. Lack of competition in the market

6. Inequality

Externalities

Externalities are external to a market and are ‘dumped’ on third parties. They are external to a market transaction.

Negative externalities equation

Social costs = Private costs + External costs

Social costs

Costs to society as a whole including all private and external costs

Private costs

Costs internal to a firm/economic agent that they directly pay for; accounted for by the price mechanism

External costs

Costs that are external to an exchange and are third party effects; ignored by the price mechanism

Positive externalities equation

Social benefit = Private benefit + External benefit

Social benefit

Benefits to a society as a whole including all private and external benefit

Private benefit

The direct benefit which accrues to individual buyer or seller accounted for by the price mechanism

External benefit

Benefits that are external to an exchange and are third party effects ignored by the price mechanism

Negative production externalities

External costs that occur as part of the process of producing products e.g pollution.

Consumption externalities

Externalities generated in the course of consuming a good or service

Marginal

The addition from one extra unit

Demerit good

A good for which the benefits of consumption are greater than the social benefit

Merit good

A good for which the social befit of consumption exceed the private benefits

Characteristics of a demerit good

1. Negative externalities

2. Information problems

Demerit goods and negative externalities

When someone consumes a demerit good, negative externalities are generated which harm others (e.g. passive smoking)

Demerit goods and information problems

People may ignore or downplay the long term private costs that they may experience later in life. People, notably younger people, tend to be short-sighted with respect to the costs of consuming a demerit good

Characteristics of merit goods

1. Positive externalities in consumption

2. Consumption is affected by imperfect information

Merit goods and positive externalities

When someone consumes a merit good, the positive externalities benefit others. The social benefit to wider society is greater than the private benefit

Merit goods and information problems

The long term private benefit of consumption exceeds the short-term private benefit of consumption

Production externalities

When production of a g or s imposes external costs or benefits on third parties outside the market so that the are not reflected in market prices

Government intervention to deal with negative externalities

1. Landfill tax

2. Aggregates Levy

3. The climate change

4. The congestion charge

5. Plastic bag tax

Problems with taxes to reduce pollution

1. Assigning the right level of taxation

2. Imperfect information

3. Consumer welfare effects

4. Employment and investment consequences

5. Low-income groups may not be able to pay

6. Higher taxes might cause inflation - worsen international competitiveness

7. Might encourage ‘boot-leggin’

8. Difficulties in working out who is causing pollution.

Price ceiling

Also known as a maximum price, this is a price above which it is illegal to trade

Reasons for price ceilings (max price)

1. Shortage of foodstuffs threatens large rise in the free market price

2. Rent controls on properties

Problems with price ceilings

1. Since the price ceilings has been imposed below the free market equilibrium price, it creates excess demand. There is no mechanism to get rid of excess demand

2. Black markets - an illegal market in which the market price is higher than a legally imposed price ceiling. They develop where this is excess demand.

Price floor

Also known as a minimum price, this is a price below which it is illegal to trade. It must be set above the free market price.

Example of price floors (minimum price)

National Minimum Wage

Characteristics of public goods

1. Non-rivalry

2. Non-excludable

3. Non-rejectability

Private goods

These goods are in rivalry and excludable in consumption

Reasons why public goods are under-provided

1. Free rider problem: once a public good is provided for one person, it is provided for all

2. The valuation problem: Difficult to measure the value obtained by consumers of public goods.

Quasi-public goods

A good which is not fully non-rival and/or where it’s possible to exclude people from consuming the product. E.g. tols

Intertemporal decisions

How an individual’s current decisions affect what’s available in the future.

internalities

The long-term benefit/costs to an individual’s current decisions that are not properly considered when making a decision to consume a good or service (e.g. lung cancer from smoking)