economics (market failure)

market failure

failure of the market to achieve allocative efficiency

types of market failure

overprovision of demerit goods (negative externalities of consumption)
underprovision of merit goods (positive externalities of consumption)
underprovision of public goods
underprovision of positive externalities of production
overuse of common access resources
threat to sustainability (negative externalities of production)
asymmetric information

demerit goods

goods that are bad for the consumer and society as a whole
in a free market, demerit goods will be readily available and relatively inexpensive
overprovided
consumers of these goods are unhealthy, unproductive, and don't contribute to society
society has to pay for their healthcare costs

merit goods

goods that benefit the consumer as well as society as a whole
in a free market, merit goods will be rare, expensive, and only consumed by the wealthy
under-provided
educated people are more productive, commit less crimes, pay more taxes, and have jobs, and cost society less in health care

public goods

goods which benefit society and are non excludable and non rivalrous
like street lights

non excludable

impossible to prevent someone from using it once its provided

non rivalrous

when someone consumes the good it is still there to be consumed by others

free rider problem

people use public goods without having to pay

quasi public good

goods that don't neatly fit the description of non-rivalrous and non-excludable, but might serve a public good
example would be museums

common access resources

essentially free to the user and anyone can get access to the resource
rivalrous and non excludable

government intervention

if the free market results in market failure it is the role of the government to interfere

earn government revenue

reason governments may want to intervene
earn revenue from indirect taxes by placing them on goods with price inelastic demand

support firms

reason governments may want to intervene
aid small firms or firms in areas the government want to grow through subsidies or price floors

support households on low incomes

reason governments may want to intervene
support poor households through subsidies or direct provision

influence the level of production

reason governments may want to intervene
support firms that produce merit goods
through subsidies, price floors

influence the level of consumption

reason governments may want to intervene
increase consumption of merit goods and decrease consumption of demerit goods through subsidies or indirect taxes and legislation and regulation

correct market failure

reason governments may want to intervene
governments are the only ones that can fix market failure

promote equity

reason governments may want to intervene
fix the unequal distribution of wealth that the free market creates

negative externalities

external costs that are paid by a third party (society) due to a financial transaction

negative externalities of production

when there is a cost to the community that is greater than the cost of production paid by the firm
MSC is greater than MPC
example. production of fossil fuels

welfare loss

when the market is not able to achieve allocative efficiency and community surplus is reduced

positive externalities of production

when there is a benefit to society that is greater than the private benefit of the producer
MSC is greater than MPC
example. tree farms

negative externalities of consumption

when society would benefit if less of a good or service was consumed
MPB is greater than MSB
example. drugs, cigarettes

positive externalities of consumption

when there is a benefit to society that is greater than the private benefit of the consumer
MSB is greater than MPB
example. education

indirect tax (pigouvian)

type of government intervention
tax placed on the firm for every unit of output of a good or service
firms raise prices and the consumer pays for part of the tax indirectly
shifts supply to the left
placed on demerit goods
shifts supply vertically up or down

carbon tax

type of government intervention
indirect tax placed on producers who emit carbon into the atmosphere
the more carbon emitted the higher the tax
firms raise prices and the consumer pays for part of the tax indirectly

subsidies

type of government intervention
payments to a firm to encourage the production of a good or service
used for merit goods
reduce costs for firms
shift supply to the right

government responses to market failure

subsidies
indirect taxes
carbon taxes
tradable permits
direct provision
contracting private firms
price floors
price ceilings
legislation and regulation
education
self governance
international agreements

tradable permits (cap and trade)

type of government intervention
potential solution to carbon emissions and global warming
government places a CAP on how much each firm can pollute, firms are issued permits to pollute a certain amount
firms who keep their level of pollution under the cap can TRADE their remaining permits to a firm who can't keep their pollution levels under the cap
supply is fixed and demand will go down
government can reduce the cap, shifting supply to the left and reducing carbon emissions

evaluation of tradable permits

uses the market to solve market failure, supply and demand are set by the price of permits, firms are motivated by profits to reduce emissions
cap can be reduced over time, further reducing carbon emissions
reduce carbon not the output
firms that switch to lower pollution levels with the least expense will do so

what should the cap be? how much is enough pollution? how high do the fines need to be?
any fine or tax will increase costs of firms making them less competitive
it will take a lot of regulation and policing to enforce this
political favoritism is an issue

evaluation of subsidies

increase in consumer and producer surplus
government loses money
society benefits

evaluation of carbon taxes

reduces consumer and producer surplus
government earns money
society benefits

evaluation of indirect taxes

reduces consumer and producer surplus
government earns money
society benefits

direct provision

type of government intervention
government directly providing merit goods, public goods

evaluation of direct government provision

consumer surplus increases because they have more goods at little to no cost
governments lose because they have to spend time and resources to provide these goods
society benefits from these public and merit goods
governments are not motivated to keep costs low because there is no profit motive

contracting private firms

type of government intervention
governments hire private firms to provided public and merit goods
paid for with tax revenue
firms bid on contract and government selects the best bid

evaluation of contracting private firms

consumers benefit because consumer surplus increase and live better overall
producers benefit because revenue and producer surplus increases
government doesn't benefit due to opportunity cost and spending money and resources
society benefits because there are more public and merit goods

legislation and regulation

type of government intervention
legislation are laws that ban or limit the supply/consumption of a good or service
regulation are rules that limit the consumption or production of goods and services
can be laws that ban or limit demerit goods
educate people on merit goods
maintain consumption of common access resources

evaluation of legislation and regulation

consumers and producers of demerit goods are hurt as they loose surplus and revenue
consumers and producers of merit goods are helped as they gain surplus and revenue
government doesn't benefit as they have to spend more resources to enforce these laws
society benefits as society is healthier and more productive

legislation and regulation on demerit goods

legislation and regulation on merit goods

education

type of government intervention
using education inititatives

evaluation of education

consumers and producers of demerit goods are hurt as they loose surplus and revenue
consumers and producers of merit goods are helped as they gain surplus and revenue
government doesn't benefit as they have to spend more resources to enforce these laws
society benefits as society is healthier and more productive

international agreements

type of government intervention
sustainability and global warming require cooperation of all nations to address
some governments place global competition above environmentalism
who is gonna monitor and control international agreements

evaluation of international agreements

consumers and producers of demerit goods are hurt as they loose surplus and revenue
consumers and producers of merit goods are helped as they gain surplus and revenue
government doesn't benefit as they have to spend more resources to enforce these laws
society benefits as society is healthier and more productive

collective self governance

type of government intervention
everyone works together without government intervention
to work: everyone must have a way of communicating with each other and there must be clearly defined boundaries

evaluation of collective self governance

consumers and producers of demerit goods are hurt as they loose surplus and revenue
consumers and producers of merit goods are helped as they gain surplus and revenue
society benefits as society is healthier and more productive

asymmetric information

when one party in an economic transaction possesses more information than the other party

adverse selection

type of asymmetric information
when one party has more information than the other party about the quality of the product

moral hazard

type of asymmetric information
when one party takes risks that another party might have to pay for like insurance of financial advisors

government responses to asymmetric information

legislation, warning ads, regulation, provision of information, licensure, screening, signalling

licensure

government response to asymmetric information
rules and regulations which require professionals to have a license or certificate to practice

signaling

government response to asymmetric information
used by the party with more information (usually the seller)
technique in which seller convinces buyers that the product is good quality
examples. warranties

screening

government response to asymmetric information
method used by the party with less information (usually the buyer)
when consumers seek to obtain more information about the product

price ceilings

type of government intervention
when the government places a maximum amount that a producer can charge for a good or service
designed to protect consumers
most common for food and housing needs
must be below equilibrium to have an effect
requires government subsidies on top of it to work and shifts supply to the right and removes excess demand so that producers and consumers both win

evaluation of price ceilings

shortages and excess demand
some consumers get the good at a lower price and some consumers get nothing because of excess demand
producers have a reduction in producer surplus and revenue decreases
society loses becuse welfare loss is created and too few resources are allocated for production however it might be worth the loss, market failure remains
government are losers: either the government doesnt apply subsidies and increases unemployment or government pays for subsidies to eliminate excess demand
eliminates price rationing so the development of underground markets may occur

non price rationing

first come first serve
distribution of coupons
sell to favorite consumers
underground markets

price floors

type of government intervention
when the government places a minimum amount that a producer can charge for a good or service
designed to protect producers
most common for essential firms
must be above equilibrium to have an effect
requires government purchases on top of it to work and shifts supply to the right and removes excess surplus so that producers and consumers both win

evaluation of price floors

surpluses and excess supply
consumers are losers: reduction in consumer surplus as price goes up and demand goes down, some consumers will not be able to afford the good
producers charge a higher price for their good as price goes up and demand goes down, will not sell much og their goods
revenue goes down
society loses because welfare loss is created and too many resources are allocated for production however it might be worth the loss, market failure remains
government are losers: must buy products from producers to eliminate excess supply, can give excess supply to poor communities, and opportunity cost of the money for surplus