Econ- market failure

Market failure

• Normally, supply and demand balance each other, and price changes help maintain equilibrium, but in a market failure, an external factor disrupts this balance.

• Market failure is when resources are distributed inefficiently in a free market. Total economic surplus is not maximized

• Individuals acting in rational self-interest make decisions that harm the group overall.

• Outcomes are not economically efficient or optimal.

• Not all bad outcomes in markets are considered market failures.

• Fixing market failures often involves government intervention, but sometimes private actors can address the issue.

• Some market failures may not have a solution, even with regulation or increased public awareness.

Externality

is an unintended consequence of economic production or consumption.

• Externalities occur when the full social costs or benefits of a good or activity are not reflected in the market price.

• environmental externalities (e.g. pollution), the issue arises due to a lack of property rights — no one owns common resources like the air or oceans.

• These resources are open access and have no price, leading to overuse and exploitation, since individuals have no incentive to conserve or use them efficiently.

Social benefit

private benefit + external benefit

Positive externality

occur when the consumption or production of a good causes a benefit to a third party. The social benefit> private benefit

Positive consumption externalities +draw and explain graph

Education benefits the individual and also society (e.g. by allowing them to educate others).

Good architecture. Choosing a beautiful design for a building will give benefits to everybody in society.

SMB is greater than PMB, SMB curve is right of the original demand curve. Deadweight loss below demand and above supply (triangle is high up) because we are under consuming the good- represents lost welfare.

Positive production externalities + draw and explain graph

Farmer and beekeeper.

SMC is less than PMC, SMC curve is right of original supply curve. Deadweight loss below demand and above supply because we are under-producing the good.

Negative externality

occur when the consumption or production of a good causes a harmful effect to a third party.

Social benefit is less than private benefit.

Negative production externality+ draw and explain graph

SMC is greater than PMC, SMC curve is left to original curve. Deadweight loss above demand curve below PMC supply curve because we are over producing the good.

Negative consumption externality+ draw and explain graph

Consuming alcohol leads to an increase in drunkenness, increased risk of car accidents and social disorder. • Consuming loud music late at night keeps your neighbours awake.

SMB is less than PMB, SMB curve is to the left of original demand curve. Deadweight loss below supply curve above new demand curve.

Government policy for externalities

• Take action to reduce the production of goods causing negative externalities (tax on cigarettes, fishing licenses).

• Try to encourage an increase the consumption of goods creating positive externalities (e.g. subsidized education and public healthcare.

• means forcing the market to recognise and include the external cost or benefit in the market place.

Internalizing positive consumption externality:

Pay a subsidy to consumers equal to the external benefit. Shifts private demand curve to social demand curve. Producers receive more, consumers pay less, quantity increases

Internalizing negative production externality:

impose a tax on producers equal to the external cost, force the polluter to pay. The tax shifts the firm’s private supply curve to the social supply curve, increasing price and decreasing quantity.

Market power

• A firm's ability to influence price by controlling supply, demand, or both.

• Gives them power to control their profit margin

• Firms with market power are price makers.

• They can establish or adjust the marketplace price of an item without losing market share.

• May create barriers to entry for other firms.

Market share

Percentage of total sales in an industry generated by a particular company. calculated by dividing the company's sales or earnings over a certain period by the industry's total sales or earnings during the same period.

Competitive market

• Many small firms

• Free entry and exit

• Minimal product differentiation

  → If these are missing, the market is imperfect.

• maximizes total surplus so the market is efficient.

Imperfect market

• Companies have significant market share because of barriers to entry.

• So they have market power and can set prices artificially higher to maximize profit by restricting output for higher prices.

• Producer surplus increases but consumer surplus decreases (pay more for less). Results in a fall in total surplus- deadweight loss, market inefficiency where economic welfare decreases for society (optimal output not produced)

Barriers to entry and examples

anything that blocks the entry of new firms into a market or industry

Government regulations, e.g. Australia Post having a government license to operate

Patents, e.g. particularly in the pharmaceutical industry, gives protection in Australia for up to 17 years

Technology barriers, e.g. Microsoft supplies the operating system used in most computers

Start-up costs, e.g. economies of scale benefit those companies already in the market

Licensing requirements, e.g. pubs being limited to just a few in one area

Controlling a scare resource, e.g. mining companies

Extensive product differentiation, brand proliferation, large advertising budget, controlling retail outlets, e.g. Coca-Cola

Collusive behavior between firms in the market, e.g. price fixing

Examples of imperfect markets

monopoly, duopoly, oligopoly

oligopoly

• Just one firm

• 100% of the market share

• e.g. Synergy (although it is regulated by the government)

monopoly

• A few large firms

• A market is considered ‘concentrated’ if the four largest companies have a combined market share of over 75 per cent.

• e.g. the grocery sector: Woolworths, Coles, IGA, Aldi make up over 82% of the market

• e.g. the Big Four banks (CBA, Westpac, NAB, ANZ) control a significant portion of both household deposits and home loan lending, with 73% of the share of owner-occupied loans to households and the same percentage of household deposits.

duopoly

• A duopoly is a type of oligopoly where two firms have dominant control over a market

• e.g. not a 'true' duopoly, but Coles and Woolworths hold a significant percentage of the Australian grocery market, with some estimates suggesting they control around 65-67% of sales

anti competitive behavior

Any agreement or arrangement between firms that seek to restrain competition and thereby remove the automatic regulation that competitive markets achieve.

Examples of anti-competitive behavior:

• Cartel - when firms collude instead of compete, e.g. price-fixing and market sharing

• Collusion - agreement between firms to either price-fix or market share to reduce competition

• Market sharing - dividing a market into smaller markets, each supplied by one firm

• Collusive tendering - firms agree to submit high tenders for government work and share the work and the high profits

• Predatory pricing - companies with substantial market power set prices sufficiently low to drive competition out of the market

• Resale price maintenance - suppliers set the price that retailers must sell products for and not allow them to offer discounts

• Exclusive dealing - imposing restrictions on another firm's freedom to choose with whom or where they deal

• Collective boycott - a group of businesses agree to not buy or sell to a business with which they are negotiating

• Merger - two or more firms join together to form one larger firm (only prohibited if it substantially reduces the competitiveness within the market)

ACCC

• Prevent anti-competitive conduct by firms with market power (e.g. price-fixing, collusion).

• Enforce penalties for violations (e.g. Colgate-Palmolive fined $18 million in 2016 for price-fixing detergent prices).

• Enforces Australian Consumer Law to protect consumers from harmful business behavior.

• Aims to strengthen competition to improve economic efficiency and welfare.

Regulation caution for government regulations

• Government regulation must avoid unintentionally reducing competition by:

  • Limiting the number of types of business

  • Limiting availability of firms to compete

  • Reducing incentives to compete

  • Limiting consumer choice and access to information

Price systems

• helps markets allocate resources efficiently by sending price signals:

  • When prices rise, consumers are encouraged to buy less and seek substitutes.

  • Producers are incentivized to supply more due to the potential for higher profit.

• This system works well for most essential goods (e.g. milk, bread, meat, vegetables).

• However, some goods and services have no price attached and therefore won’t be provided by markets.

Key ways to classify

Rival: If one person consumes the good, it reduces the amount available for others.

Excludable:If it is possible to prevent someone from using the good without paying for it.

Private goods

• Rival: Yes

• Excludable: Yes

• Characteristics:

  • Purchased by households, legally owned with a receipt.

  • Markets provide these goods efficiently since consumers are willing to pay.

  • Not subject to market failure in most cases.

  • Examples: A computer, mobile phone, t-shirt, sausage

Club goods

• Examples: Netflix, the internet, gym memberships, cinema movies (if seats are available)

• Rival: No (as long as capacity isn’t exceeded)

• Excludable: Yes

• Characteristics:

  • Can be consumed collectively by many people at the same time.

  • Access can be restricted to paying users.

  • Profitable for private firms to provide.

Public goods

• Rival: No

• Excludable: No

• Characteristics:

  • Cause market failure — private producers won’t supply them as they can’t be priced or sold profitably.

  • Free riders benefit without paying, so there’s no financial incentive to produce.

  • Funded by the government through taxes because they are essential for society’s welfare.

  • Sometimes private firms provide public goods (e.g. free-to-air TV, radio) funded by advertising or sponsorship.

  • Examples: Street lights, national defence, lighthouses, national parks, police services

Public goods- market failure

• Cause market failure — private producers won’t supply them as they can’t be priced or sold profitably.

• market failure is caused by free riders. It is an acceptable failure. Government has acted by providing a good that has a social benefit because the private free market wouldn’t be able to supply it. The benefit of having public goods is better than not having it.

Merit goods

• Public transport, public education, and public healthcare are not public goods.

• Can be priced and are often excludable

• May be congested (limited access at times)

• Provided by governments due to their large positive externalities (benefits to society)

Common resources

• Rival: Yes

• Excludable: No

• Characteristics:

  • Market failure occurs because these goods are non-excludable but rival.

  • No clear ownership leads to overuse (e.g. overfishing).

  • One person’s consumption imposes a negative externality on others.

  • Known as the “tragedy of the commons” — individuals acting in self-interest can deplete shared resources.

  • Government regulation is needed to manage use (e.g. through quotas, licences, protected areas).

• Examples: Fish in the ocean, elephants, rhinos

Common resources- market failure

• Market failure occurs because these goods are non-excludable but rival.

governments will intervene in the market by trying to protect the resources through quotas, licenses or regulations

free riders

• Free riders are people who consume a good without paying for it.

• If too many people free ride, the good may be underprovided or not provided at all, since there’s no profit incentive for private producers.

• This leads to market failure — the market doesn't allocate resources efficiently or equitably.

• Especially problematic for public goods and common property goods.

• Government intervention is essential to correct the market failure and ensure these goods are available to all by funding these goods through tax revenue.