3.1.6 Market failure

Allocative efficiency

Where society produces the right amount of the right goods at the right price

Productive efficiency

Production of g/s at the lowest factor costs

Market failure

Where the market mechanism fails to allocate resources efficiently

5 Examples of market failure

Resource immobility, inadequate provision of merit goods, demerit goods, inequality, externalities

Social Cost formula

Private Cost + External Cost

Social Benefit formula

Private Benefit + External Benefit

Externalities

When a third party is affected by the decisions and actions of others

Negative production externality

Social cost > private cost

Negative production externality example

Pollution

Positive Production Externality

Social Cost < Private Cost

Positive production externality example

Training workers

Negative consumption externality

Social benefit < Private Benefit

Negative consumption externality example

Cigarettes

Positive consumption externality

Social Benefit > Private Benefit

Positive consumption externality example

Vaccinations

2 Advantages of taxes as a method of government intervention

Increased tax revenue, disincentives production of demerit goods

2 Disadvantages of taxes as a method of government intervention

Evasion, inequality (depends on percentage of income)

Advantage of subsidies as a method of government intervention

Increased substitution of demerit goods for merit goods (increased supply = lower prices)

2 Disadvantages of subsidies as a method of government intervention

Increased costs for tax payers, excess production

2 Advantages of regulation/legislation as a method of government intervention

Fairer, faster than tax

2 Disadvantages of regulation/legislation as a method of government intervention

Socially inefficient, encourages crime

2 Advantages of price ceilings/floors as methods of government intervention

Price ceilings control inflation, price floors decrease labour exploitation

2 Disadvantages of price ceilings/floors as methods of government intervention

Price ceilings could lead to shortages, price floors could lead to overproduction

Advantage of compensation/provisions as methods of government intervention

Accessible to everyone

Disadvantage of compensation/provisions as methods of government intervention

Increases costs for tax payers (welfare costs)