Market failures

Efficiency of competitive markets

Competitive market + consumption/production doesn’t affect others negatively

Maximised gains from trade

Consumer value > production cost: units produced & consumed

Market failures

Negative (external) effects, gains from trade not maximized, curves don’t reflect consumer value/ total cost to society

External effects /Externalities

Impact of my actions on a bystander

Negative: emissions, smoking

Positive: vaccines, education

Market failure due to negative externalities

Production cost + societal cost (not included in marginal cost of production)

Societal cost > consumer value

Marginal external cost

Cost for bystander when one more unit produced

Marginal social cost

Marginal private cost + marginal external cost

Efficient production & consumption

Marginal social cost = marginal social benefit (demand curve)

Overproduction of markets when negative external effects

Solution: Coasean bargaining

Party 1: has property rights

Party 2: doesn’t

—> bargain, private agreement

Critique of Coasean bargaining

! unfair, because of compensation demands

! complicated when multiple parties

! damages not quantifiable

Governmental solution: Regulation

Regulate/limit production → benefits one party, harms the other (profit loss)

→ easy fix

Governmental solution: Taxation

Ideal tax: shifts supply curve from MPC to MSC

Pigouvian tax

Tax on activities that generate negative external effects, actors face social cost themselves

→ efficient, incentives for firms, easy to monitor

Governmental solution: Compensation

Actors need to compensate bystanders for cost of negative external effects

Governmental/EU solution: Tradeable pollution permits

1) choose pollution level

2) distribute pollution permits

3) firms who lower pollution sell permit to firms with higher pollution

Market failure due to positive externalities

Underconsumption of goods with positive externalities

Market equilibrium too low

Solutions to market failure due to postive externalities

Subsidies

Patents create incentives

Excludable goods

You can stop person from using/consuming it

Rival goods

You use it, the other person can’t use it/ impacts their use of the good

Private goods

Excludable + rival → Food

Public goods

Not excludable, not rival → Street lights

! Free-riders → taxation

WTP society/ benefits > cost for society → cost benefit analysis

Common resources

Rival but not excludable → Water

! tragedy of the commons → taxation, privatization

Club goods

Excludable, not rival → Netflix

Repugnant markets

Market conflicts with ethical norms e.g. organs, humans

Merit goods

Goods should be available to everyone