Market Failure

Definition

• Inefficient allocation of resources (e.g. when too much/little of a good is being produced/consumed).

• PS: equilibrium is not always socially desirable.

Positive/negative externalities

Benefits/costs to a 3rd party not part of a transaction.

(De)Merit goods

When consumption/production causes positive/negative externalities.

Demerit goods diagram & explanation

• Q*: socially efficient allocation

• Q1: free market allocation

• MPC/MSC: marginal private/social cost

• MPB/MSB: marginal social benefit

• Demerit good = negative externalities = MSC > MPC = welfare loss (shown in triangle between Q* to Q1)

• As there is no social benefit to demerit goods: MSB = MPB and is constant

Demerit goods diagram & explanation

• Merit good = positive externalities = MPB > MSB = welfare loss (shown in triangle between Q* to Q1)

• As there is no social cost to merit goods: MSC = MPB and is constant

Solutions to demerit goods

• Indirect taxes

• Information Campaigns

• Bans

• Subsidising Healthier Alternatives

• Minimum Price Schemes (decreases affordability)

Solutions to merit goods

• Subsidies

• Information campaigns

• Maximum Prices (increases affordability)

• Government Provision (100% Subsidy e.g. State Education)

Public goods (incl. examples)

When goods are:

• Non-excludable (you can’t stop others from consuming the good if you have paid for it)

• Non-rivalrous (your consumption of a good does not diminish the amount that is available for consumption for others)

Examples:

• Street lights

• Lighthouses

• Military

• Quasi (Semi)-Public goods e.g. parks/roads

Solution to public goods

• Government provision: these have to be provided by the state

• Why?: no rational consumer would pay for them due to non-excludability & non-rivalry.

Asymetric Information (incl. examples)

• When buyer & seller have unequal information about the true market conditions.

• This leads to a not truly reflective equilibrium price of the correct efficient allocation of resources

Examples:

• A dentist prescribing non-essential work to customers to increase the dentist’s revenue.

• A consumer lying about the amount of cigarettes they smoke on a life insurance questionnaire.

Solutions to Asymetric Information (incl. examples)

• Regulation to prevent anyone exploiting their knowledge

• Information campaigns by government to increase awareness amongst consumers/producers to prevent exploitation.

Examples:

• Dentists lose their license if they prescribe non-essential treatment.

Unstable Commodity Markets

• As agricultural markets depend on weather conditions/climate: very difficulty to determine supply.

• Consequently: can supply fluctate radically =

• Impacts on product price =

• Impact of farmer incomes =

• Disincentivise farmers to stay in market =

• Vital agricultural products soar in price (due to fall in supply)

Solution to Unstable Commodity Markets

Buffer Stock Schemes: government buys up surplus stock in a good harvest year & stocks it & releases it again in bad harvest year.

Therefore: supply is constant & prices don’t fluctuate.

Labour Immobility (incl. examples)

When jobs are available and labour is searching for jobs but they can’t take up the vacanies due to immobility.

Geographical immobility:

• Impractical commuting

• Relocation not possible due to:

• House price differentials, schooling, social life, partner’s job

Occupational immobility:

• Unemployed don’t have right skills/qualifications needed for available jobs (structural unemployment).

Solutions to Labour Immobility

Geographical immobility:

Investment in:

• Transport links

• Subsidising housing

• Increasing awareness of jobs available in different parts of the county

Occupational immobility:

Investment in:

• Education

• Training schemes

• Apprenticeship programmes

• Impact: allows workers to have wider skills & re-train to enter new profession easier