unit 8 market failure, gov intervention NOT DONE

negative production externalities

• social costs

  • air pollution

  • waste

• MSC > MPC

analysis

• self interest

• over production

• price is too low

  • encourages more consumption

• misallocation of recourses

• allocative inefficiency

  • allocative efficiency = P* Q*

externality def

a consequence of an economic activity that is experienced by unrelated third parties

negative consumption externalities

• cost to a third parties as a result of actions of consumers

• MPB > MSB

  • smoking

  • alcohol

analysis

• self interest - consumers ignoring social costs

• misallocation of resources at Q1 P1

  • overconsumption and overproduction

• allocative inefficiency

  • allocative efficiency = P* Q*

• welfare loss to society

positive consumption externality

• benefit to third parties as a result of consumers action

  • healthcare

  • education

• MSB > MBP

  • by not producing at q*, society is losing out on potential social benefit

analysis

• self interest - consumers ignoring social benefit

• under consumption

• misallocation of resources

  • too few resources being allocated to this market

positive production externality

• benefit to third parties as a result of actions of producers

  • training

  • R and D

• MPC > MSC

• by not producing the extra units (Q1 to Q*) society is losing out on welfare

analysis

• producers only consider private costs - self interest

• under production

• resources are allocated at the private optimum not the social optimum

  • misallocation of resources

  • allocative inefficiency

• welfare loss

merit good def

• goods that are more beneficial to consumers than they realise - generate positive consumption externalities

  • healthcare

  • education

• reasons for this

  • imperfect information

  • information failure - consumers don’t understand the benefit

  • asymmetric information

imperfect information

one party do not have complete or accurate information to make informed decisions, leading to suboptimal choices

asymmetric information

one party has more information that another

moral hazard

• a situation where one party takes risks because they do not bear the consequences

• insurance is an example where the insured party may engage in riskier behaviour, knowing that they are protected from the costs of that risk

adverse selection

buyers or sellers of a product are able to use their private knowledge of the risk factors involved in the transaction to maximize their outcomes, at the expense of the other parties to the transaction

de merit goods

• goods deemed more harmful to consumers than they realise

• why

  • information failure - information is ignored / not presented

  • asymmetric information - producers have full information but don’t share it with consumers

• generates negative consumption externalities

  • alcohol

  • gambling

• overconsumed / overproduced

  • irrational decisions

merit goods diagram

• underconsumption (P1 Q1) causes welfare loss

• too many resources being allocated

  • allocative inefficiency

• due to information failure

• irrational decisions made by consumers

demerit goods diagram

• too many resources being allocated

  • allocative inefficiency

• overconsumed

• welfare loss

pure public good

• non excludable

  • no price can be charged for a public good

  • the benefits of consuming a public good cant be confined to an individual who has paid for it

  • no cost efficient price

• non rivalrous

  • quality of the good doesn’t diminish upon consumption

• road signs

• street lights

free rider problem

when individuals benefit from resources or services without paying for them, leading to under provision of public goods

missing market

• a market does not supply a good or service

• due to

• lack of demand

• improper incentives

• free rider problem

  • leading to inefficient allocation of resources

quasi public good

• mix of a public and private good

• roads can be excludable - toll roads, can be rivalrous

• beaches - can be excludable, rivalrous during peak times

tragedy of the commons

a situation in which individuals acting in their own self-interest deplete shared resources, leading to environmental market failure and long-term damage to the resource

common access resources

• natural resources over which no private ownership has been established

• air

• forests

how lack of private ownership causes tragedy of the commons

• producers act in self interest and exploit common access resources

• depreciation of resource because of profit motive

• even if a producer stops because of concerns, other producers will take all the resources, meaning only the producers that has stopped will lose out

income inequality

• those on lower incomes are unable to consume

  • underconsumption

  • allocative inefficiency

factor immobility

refers to the inability of factors of production to move easily from one industry to another, leading to unemployment and inefficiency in the economy

occupational immobility of labour

inability of workers to change jobs or industries due to lack of skills, training, or experience needed

geographical immobility of labour

workers who cannot move to different locations for employment due to factors such as housing constraints, family ties, or lack of information about job opportunities

effect of unemployment in micro

• FOP not being fully utilised

• allocative inefficiency

• economy is inside PPF

monopoly cuases market failure

• as a monopoly is profit maximising, price is set to MR = MC

• restricts output as some consumers are priced out the market

• underconsumption of the good

• misallocation of resources

• lower consumer surplus

• allocative inefficiency

• also x inefficient - no incentive to lower costs or reduce waste - no competition

• are able to charge a price below AC to force new entrants out the market

  • once rivals leave, price increases

characteristics of a monopoly

• profit maximisers (MR = MC)

• price makers

• unique goods

• supernormal profit

• high barriers to entry

absence of property rights - market failure

def - legal right to control and benefit from a resources, e.g. land

production

• factory pollutes a river - no one owns the river

• costs of polluting the river are dumped on society

• negative production externality

consumption

• if people overconsume a public park, it becomes overcrowded and degraded

• each person gets a MPB

  • but the cost of wear and tear is on everyone else

• negative consumption externality

• tragedy of the commons

complete market failure

market is unable to allocate resources efficiently, leading to a total lack of supply for a good or service

partial market failure

• market produces the wrong quantity, leading to inefficient allocation of resources

• fails to deliver socially optimum outcome

government intervention

the actions taken by a government to correct market failures, regulate markets, or provide public goods and services

• subsidies

• tax

• regulation

• information provision

• price controls / pollution permits

• state provision

indirect tax

• uses

  • correct market failure

  • raise government revenue

• def - expenditure tax, an extra charge when goods and services are sold

• increase costs of production for firms

  • can be passed onto consumers in the form of higher prices

specific unit tax

• tax placed on each item regardless of price

• increase cost of production

• solves overconsumption/production

• promotes allocative efficiency whilst generating government revenue

ad valorem tax

• percentage tax on top of price

• increase cost of production

• solves overconsumption/production

• promotes allocative efficiency whilst generating government revenue

price elastic indirect tax

• consumer burden - lower

• producer burden = higher

• tax revenue = lower

price inelastic indirect tax

• consumer burden = higher

• producer burden = lower

• tax revenue = higher

indirect tax evaluation

• effectiveness at reducing consumption depends on PED

  • if demand is price inelastic - quantity demand wont fall

• if gov have imperfect information, tax rate could be too hight

  • consumers avoid tax

    • black market

    • smuggling

  • firms shut down / leave country

    • unemployment

  • lost tax revenue

• regressive tax promotes income inequality

subsidies

money grant to firms by the government to reduce costs of production and encourage an increase in output

• uses

  • solve market failure

  • increase affordability - necessity’s, under consumed goods

• consumer + producer incidence = gov spend

price elastic subsidy

• producer benefit increase

• consumer benefit decrease

price inelastic subsidy

• producer benefit decrease

• consumer benefit increase

benefits of subsidies

• encourage production of merit goods

  • benefit society

• lower price encourages competition

• supports unestablished industries

• solves underconsumption/production

• allocatively efficient

  • welfare gain

subsidies evaluation

• firms may become reliant of subsidies which can lead to inefficiencies

• opportunity cost of subsidy - cuts to healthcare spending

• is government acting with perfect info - could be a higher cost to government

• effectives depends on elasticity

  • needs to be price elastic demand to solve market failure

minimum price / price floor

• a fixed price enacted by the government usually set above the equilibrium price\

• why

  • protect producers from price volatility

  • solve market failure - discourage consumption of demerit goods

ADV minimum price

• producers have guaranteed minimum income

  • encourage investment and dynamic efficiency

• stockpiles can be used when supply is reduced

• discourages consumption of demerit goods, increasing society welfare

DIS minimum price

• consumers pay more - less consumer surplus, less PP

• producer revenue depends on if the government are intervention buying

• if PED is inelastic it may not solve market failure - but consumers revenue will increase

• can incentivise black markets or find alternatives

• recourses used to producer excess supply could be used elsewhere - opportunity cost, allocative inefficiency

• dumping excess supply - worsen international relations

maximum price / price ceiling

• a fixed price enacted by the government usually set below the equilibrium market price

• uses

  • improve affordability of necessity’s

  • doesn’t exclude those on lower incomes

• extension in QD

• contraction in supply

  • producers are less willing and able to supply

  • producers cant satisfy demand

• lower producer revenue - dynamically inefficient

ADV maximum price

affordability increases

DIS maximum price

• some consumers cant access the good due to excess demand - shortage

  • may be forced to alternative supply

  • smuggling, black markets

• fall in producer revenue and surplus

• unintended consequences - black markets

  • may have to intervene with subsidy to meet demand

• enforcement costs - high admin costs

state provision

• direct provision of goods and services by the government free at the point of consumption

• why

  • free market fails to produce at the right quantity

  • merit goods are under consumed and underproduced

  • public goods, missing market

  • inequitable distribution of income

DIS state provision

• cost to taxpayer

• may lack information about price and quantity

• gov may lack dynamic, productive and X efficiency as they are not profit maximisers

• excess demand

regulation

• rule / law enacted by the government that must be followed by economic agents to encourage a change in behaviour

• aim

  • reduce negative externalities

  • change monopoly / oligopoly behaviour

  • improve inequitable distribution of income

• can be restrictive or prohibitive

DIS regulation

• cost - regulators (administration)

• fines for breaking rules may not be enough of a deterrent

• unintended consequences - high regulation causes firms to shut down or leave the country

• lots of regulation may reduce productive efficiency (red tape)

pollution permits

• giving firms a legal right to pollute a certain amount

• if a firm pollutes less it can sell its pollution permits to other firms

• if a firm pollutes more a firm has to buy more from the government

• promotes long run incentives to invest in green technology

  • increase profits through selling pollution permits

DIS pollution permits

• enforcement costs - opportunity cost

• gov may have imperfect information - cap may be set at the wrong level

• unintended consequences - increases cost of production for firms - may shut down - or pass on costs to consumers

information provision

government funded information provision to encourage or discourage consumption through advertising or education

information provision with merit goods

• there is under consumption and production

• demand shift as consumers make rational decisions

• with info provision, MPB will move right to MSB ( MSB = MPB + provision) at the socially optimum level

• allocative efficiency and more welfare

information provision with demerit goods

• there is over consumption and production

• demand shift as consumers make rational decisions

• with info provision, MPB will shift left to MSB (MSB = MPB + provision) at the socially optimum

• allocative efficiency and more welfare

DIS information provision

• expensive - opportunity cost

• no guarantee of success

• only effective in the long run

• gov may not have perfect information

property rights

• incentive not to exploit common access resources

• negative externality internalised to producer / owner of land

• if enforced, will reduce quantity to socially optimum level

DIS property rights

• can they be efficiently distributed

• enforcement needed - cost

• equity - who gets rights

government failure

• occurs when the government intervenes in a failing market but fail to improve the allocation of resources

• costs of intervening outweigh the benefits

  • may make existing market failure worse or create whole new market failure

  • less social welfare

distortion of the price signal - gov failure

refers to government intervention that alters the natural information conveyed by prices, leading to inefficient resource allocation

information failure - gov failure

government may not have full / correct information to enable them to make an effective decision about the best ay to allocate resources - not at Q*

excessive administration costs - gov failure

• correcting market failure can come with high militance and enforcement costs

  • regulation

  • subsidies

  • state provision

  • price controls - excess supply / demand cost

• opportunity cost

unintended consequences - gov failure

• intervention leads to am unexpected / unintended effect

  • black markets

  • negative impacts that aren’t part of the policy

    • poor - min price, taxation, less PP

  • impact on firms - subsidies can make them wasteful - X inefficient

  • employment

regulatory capture - gov failure

• interests of society are overlooked for the interests of firms

• because firms influence regulators

political self interest - gov failure

pursuit of self interest amongst politicians and government officials can lead to a misallocation of resources

policy myopia - gov failure

short-sightedness in policy-making that focuses on immediate benefits rather than long-term effects, often leading to negative outcomes

free market

any place where buyers and sellers meet to exchange goods and services, free from government intervention

ADV free markets

• allocative efficiency

• encourage competition

• dynamic efficiency - investment

• job creation, economic growth

• no risk of government failure

DIS free markets

• markets can fail - monopoly / oligopoly

• inequity given inequality - may exclude consumers

• creative destruction - cost cutting in dangerous areas like safety

• price volatility

price volatility

the tendency for prices to fluctuate significantly over short periods due to market instability or changes in supply and demand

why are primary commodities volatile

• demand and supply are inelastic

  • lack of substitutes

  • production lag

  • hard to store'

• regular shifts in demand and supply

  • supply - weather

  • demand - global growth

consequences of price volatility

• less tax revenue

• less revenue for firms

  • recessions

  • lower investment

principles of UK competition policy

• promoting competitive markets

• preventing anti-competitive practices

• merger control

• market incentives and consumer welfare protection

ADV competition policy

• lower prices for consumers

• more choice

• improved efficiency

• innovation is encouraged

DIS competition policy

• enforcement costs

• regulatory failure

• reduced EOS

• compliance costs for firms

example of competition polcy

competition markets authority blocked Microsoft from acquiring Activision in 2022 but then it was allowed later with approved conditions