Income elasticity and Market Failure

market failure

market failure

any situation where the allocation of resources by a free market is inefficient

externalities

spillover effects arising from a good’s production or consumption imposed on a third party that was uninvolved in the market transaction

“pareto optimal”

a market situation where no one can be made better off without making someone else worse off; synonymous with maximisation of community surplus

positive externality of consumption

occurs when a good’s consumption creates external benefits on the rest of society than exceed the benefits enjoyed by the individual consumers of the good itself

gov’t intervention for positive externalities of consumption

legislation and regulation, education and awareness creation, direct gov’t provision, subsidy

positive externality of production

occurs when a good’s production creates external benefits on the rest of society than exceed the benefits enjoyed by the individual producers of the good itself

gov’t intervention for positive externalities of production

subsidy, direct government provision

negative externality of production

occurs when a good’s production creates external costs on the rest of society than exceed the costs imposed on the individual producers of the good itself

gov’t intervention for negative externalities of production

indirect (pigouvian) taxes, carbon tax, tradable permits, legislation and regulation, education and awareness creation

carbon tax

levied on manufacturers based on the amount of CO2 emitted through the goods’ production

tradable permits

issued to allow manufacturers to emit a certain amount of CO2

negative externality of consumption

occurs when a good’s consumption creates external costs on the rest of society than exceed the costs imposed on the individual consumers of the good itself

gov’t intervention for negative externalities of consumption

indirect (pigouvian) taxes, legislation or regulation, education and awareness creation, minimum price

public goods

a good that every person is able to benefit from but no one person’s use diminished the benefit enjoyed by the rest of society

free-rider problem

a type of market failure that occurs when those who benefit from resources, public goods and common pool resources do not pay for them or under-pay

gov’t intervention for public goods

direct provision, contracting out

contracting out

government makes an agreement with a private firm to carry out an activity that the government was previously doing itself

pros of contracting out

• better quality control

• broader range of skills and technology available

• private firm may be more flexible and innovative than the government

  → public goods are better quality and less costly

cons of contracting out

• gov’t becomes less accountable

• gov’t loses control

• may be expensive

• quality may be reduced because of lowest price

• has to be monitored which is costly (opportunity cost)

social consequence of market failure

inability of the market to achieve equity, which leads to an equal playing field in which certain groups in society enjoy higher incomes and a greater level of wealth than others

common pool resources

resources that are not owned by anyone, do not have a price, and are available for anyone to use without payment or any other restriction