Market Failure

Market failure

When the price mechanism leads to misallocation of resources

Negative externalities

costs which affect third parties outside price mechanism as a result of over consumption/production of a good

Why internalise negative externalities?

By taxing these de-merit goods, the government makes it more expensive for consumers to buy and producers to sell. This discourages the use of these goods, and protects society from their harmful third party effects

Diagram for negative externalities

negative production externalities

Private cost

cost for producer/consumer inside the price mechanism

welfare loss

excess of social cost over social benefit for a given output

Tradable Pollution Permits (TPP)

Permits which allow firms to pollute up to a certain limit. These permits can then be traded between firms-promote allocative efficiency-externalities internalised, pollution paid in most efficient way.

cap and trade system

Firstly, government set cap on how much pollution it will allow each year -this is the estimated socially efficient level of pollution-it then divides up its permits between firms until the cap is reached

Minimum price

the lowest price suppliers of a good can legally sell the good for

Why introduce Min price? (agriculture)

Gov introduce minimum price to protect farmers from very low price, to support the income of farmers

Evaluation of Min price

1) Magnitude of change in Min price is at O% so impact may/may not be significant

2) it is hard to measure what the ideal Min price should be to know whether lowering it is appropriate

3) Farmers may earn less income and lead some to close down

Regulation

When government make changes to the law to address market failure

hypothecated tax

revenue used to further solve market failure

Positive externalities

benefits which affect third parties outside price mechanism

diagram for positive externalities

positive consumption externalities

Maximum price

the highest price supplies of a good can legally sell for

Public goods

goods that are non excludable and non rival

non excludable

can’t exclude others from consuming your good (no price charged)

non rival

your consumption of the good doesn’t prevent anyone else from using it (quantity of the good doesn’t diminish upon consumption)

Free rider problem

Consumers wait for others to buy and use those for free. So no demand for public good, providers don’t supply public good because they can’t make profit-public goods underprovided by the market

State provision

direct provision of goods/services by the gov free at the point of consumption

Merit goods

goods deemed more beneficial to consumers than they realise caused by imperfect information

Demerit goods

goods deemed more harmful to consumers than they realise caused by imperfect information

Imperfect information

government funded information provision/education to encourage/discourage consumption

Asymmetric information

When one party knows more than another party in a transaction