Theme 1 - Chapter 3 - Market Failure

Market Failure

A misallocation of resources caused by the Market Mechanism.
Reasons for Market Failure:
- Missing Markets (Merit and Public Goods)
- Lack of Competition in the Market
- Externalities
- Imperfect Market Information
- Factor Immobility
- Inequality

Demerit Goods

A good which is over provided by the market mechanism and tends to yield more costs to individuals than they realise
EXAMPLES: Tobacco, Durgs, Alcohol

Externalities

The costs or benefits that are external to an exchange. They are 3rd party effects ignored by the market mechanism

Consumption Externality

An external cost or benefit arising from a consumption activity

Production Externality

An external effect of production, which neither harms nor benefits the person or firm controlling the production

External Costs

Negative 3rd parts effects that are excluded from the market mechanism

Private Costs

Costs internal to a market transaction, which are therefore taken into account by the market mechanism

Social Costs

External costs + Private costs

External Benefits

Positive 3rd part effects that are excluded from the market mechanism

Private Benefits

Benefits internal to a market transaction, which are therefore taken into account by the market mechanism

Social benefits

External benefits + Private benefits

Market Equilibrium level

Maginal private costs = Marginal private benefits

Social optimum level

Marginal social costs = Marginal social benefits
This is where society should be

Welfare loss

The excess of social costs over social benefits for a given output. A situation where MSB ≠ to MSC and society does not achieve maximum utility

Welfare Gain

The excess of social benefits over social costs

Negative Consumption Externality

Negative Production Externality

Positive Consumption Externality

Positive Production Externality

Initialising the Externality

Eliminating the externality by bringing it back into the framework of the market mechanism = Creating a market for the externality
EXAMPLES: Tradable pollution permits, Extending Property Rights, Taxes, Regulation

Public Goods

Those goods that have non-rivalry and non-excludability in consumption.
EXAMPLES: Defence, Police Service, Street Lighting, Judiciary and Prison Service

Non-Rivalry

Consumption of goods by one person does not reduce the amount available for consumption by another

Non-Excludability

Once provided, no person can be excluded from benefitting from the good/service

Private Goods

Those goods that have rivalry and excludability in their consumption

The Free Rider Problem

If left to the free market, public goods would not be adequately provided for. The market fails because firms cannot withhold the goods and services from people who refuse to pay.

Information Gaps

Where consumers, producers or the government have insufficient knowledge to make rational economic decisions

Symmetric Information

Where consumers and producers have access to the same information about a good or service in a market

Asymmetric Information

Where consumers and producers have unequal access to information about a good or service in the market.