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positive government intervention on market failures
subsidizing to encourage production of goods with positive externalities
excise tax on goods and services that have negative externalities
advertisements that highlight/educate consumers of benefits or dangers of certain goods and services
direct provision of public goods and essential services (boosts living standards)
negative government intervention on market failure
direct provision can lead to lack of competition due to lack of incentive to join market
if demand in elastic (or products are addictive), excise taxes may not significantly reduce consumption and change behaviour leading to inefficiencies
subsides may cause overproduction of good or service leading to surplus and inefficient use of resources
Pro and Cons of government intervention for efficency
can improve allocative efficiency
may lead to a reduction of productive/technical efficiency and dynamic efficiency if not implemented correctly
unintended consequences of government intervention
high excise tax may lead to black market for certain goods (e.g. tobacco, alcohol)
subsidies may cause overproduction of good or service
too many changes in prices may lead to shortages or surplus
factors that can shift PPF curve outwards
increase in factors of production (e.g. more land, labour and capital)
technological advancement (new tech leads to better productivity and efficiency)
better education for workers
more skilled workers = better productivity
what is a positive externality
Production and consumption of particular products that create benefits to third parties
benefits not involved in transaction of good or service
often goods that have positive externalites are public goods because they boost living standards
How can positive externalities lead to market failure
market often underproduces goods and services due to lack of incentive
market only considers private benefits (profit) and not external benefits (societal gain)
leading to underproduction and underinvestment of goods and services
examples of goods with positive externalities
education - more skilled, workers increase productivity, benefit society
vaccinations - public good, can help protect individuals and the entire community
renewable energy - reduce pollution and climate change
what is a negative externality
Costs not paid by the producers or consumers who have created them, that often create harmful effects on third parties
costs not reflected in market prices
leads to overproduction and overconsumption
How can negative externalities lead to market failure
market only considers private benefits (profit) and not external costs (harmful effects)
leading to overproduction or overconsumption of goods and services
examples of goods with negative externalities
pollution - using coal is cheaper to produce electricity than renewable, negative externality is polluting air from CO2
smoking - second hand smoke can harm others, increased medical needs, and reduced productivity of smokers
deforestation - negative externality is biodiversity loss and climate change
types of market failure
positive & negative externalities
public goods
asymmetric information
common access goods
how can government correct failure in public goods
direct provision of resources
subsidies to promote production of good or service
how can government correct failure in asymmetric information
advertising campaigns & informing public
laws and regulations to make all companies disclose information
how can government correct failure in positive (under production) externalities
subsidies to promote production of beneficial goods
direct provision of resources
how can government correct failure in negative (overproduction) externalities
excise tax on harmful goods and services
government law and regulations restricting production of goods and services
how can government correct failure in common access goods
government law and regulations to restrict resources to sustainable levels
taxes to make people pay for resource depletion
government law and regulations to allow controlled use of resources with permit
what are common access goods
they are rivalrous goods (consumption for one person, reduces consumption for another) and non-excludable (nobody can be prevented from using them)
often natural resources
how can common access goods lead to market failure
nobody owns or control natural resources, so individuals tend to overconsume
leading to over depletion and over consumption of resources
leading inefficient allocation of resources
if PED is > (greater than) 1…
demand is price elastic and consumers are highly responsive to price changes
if PED is < (less than) 1…
demand is price inelastic and consumers are less responsive to price changes
Goods with HIGH PED
are elastic, small changes in price = large change in demand
it is a luxury good (non-essential item)
has many substitutes (rise in the price of one product, the consumer can easily switch to a different product)
is non-addictive
requires a large proportion of income (expensive goods have more elastic demand e.g. house, car, vacation)
consumer has time (can find alternatives in short time, demand is elastic)
importance of goods with HIGH PED
goods with high PED should avoid price increase as demand will decrease significantly
discounts and promotions can help boost sales
tax on elastic goods, will lead to less demand
Goods with LOW PED
are inelastic, large changes in price lead to low changes in demand
is a necessity (essential items that consumers cannot avoid buying e.g. food, electricity, water)
few or no substitutes (no substitutes, prices can rise and consumers will still have to buy e.g. petrol, insulin)
is addictive
requires a low proportion of income (product is cheap, price changes do not affect demand as much
importance of goods with LOW PED
businesses can increase price without losing many customers, therefore maximising profits
monopoly firms can sell inelastic goods and set high prices
taxes on inelastic goods can generate high tax revenue because demand stays relatively the same
conditions for perfectly competitive market
large number of buyers and sellers (no one person can influence market price)
homogenous (identical) products
perfect information (all buyers and sellers have same information about products)
free entry and exit into market
