Chap 6: Market Failure Part 2 - Public Goods & Marginalist Principle

Marginalist Principle

Marginalist Principle

Economic agents should be focused on comparing incremental cost & benefit of a decision

Marginal Private Cost (MPC)

measure the change in total private cost as a result of undertaking an additional unit of economic activity (consuming/producing g&s)

Marginal Private Benefit (MPC)

measure the change in total private benefit as a result of undertaking an additional unit of economic activity (consuming/producing g&s)

What is implicit cost

non-monetary cost & opportunity cost

How do economic agents (consumer/producer) maximise self interest (utility/profit)

using Marginalist Principal to determine how much g&s to consume/produce to maximise Net Private Benefit (Private benefit - Private cost) where MPC=MPB

Marginal External Cost (MEC)

measure the change in total external cost as a result of undertaking an additional unit of economic activity (consuming/producing g&s)

MEC exists when there are negative externalities

Marginal Social Cost (MSC)

measure the change in total social cost as a result of undertaking an additional unit of economic activity (consuming/producing g&s)

MSC = MPC + MEC

Marginal External Benefit (MEB)

measure the change in total external benefit as a result of undertaking an additional unit of economic activity (consuming/producing g&s)

MEB exists when there are positive externalities

Marginal Social Benefit (MSB)

measure the change in total social benefit as a result of undertaking an additional unit of economic activity (consuming/producing g&s)

MSB = MPB + MEB

How do governments maximise societal welfare

using Marginalist Principal to determine how much g&s should be consumed/produced to maximise Net Social Benefit (Social benefit - Social cost) where MSC=MSB

Market failure

occurs when the workings of the free-market result in an inefficient allocation of resources from the perspective of society

Govt Intervention in Market Failure

(a) Market-Based Policies

Incentives or disincentives to consumers & producers in order to influence their decision-making (eg. taxes & subsidies)

(b) Command & Control Policies

Rules & regulations that forces consumers and producers into a decision (eg. quotas, bans, price controls, compulsory consumption)

(c) Moral Suasion

Persuasion to influence the decision-making of consumers and producers (eg. campaigns, advertising, education)

What are public goods

goods with characteristics of non-rivalry in consumption, non-excludable in consumption, non-rejectability in consumption

Non-rivalry (in consumption)

Consumption by individuals does not diminish amount available to others.

• Consumption of the good does not reduce the total supply available to others.

• Same unit of good can be collectively consumed

Non-excludability (in consumption)

Supplier cannot prevent consumption of the good once it is made available.

Non-rejectability (in consumption)

inability of consumers to refuse the consumption of a good once it has been produced.

Examples of public goods

Police & fire services

Street lighting

Lighthouses

Flood control - Dams

Public drainage

Nuclear defence system

How non-rivalry (in consumption) leads to market failure

Due to non-rivalry,

• marginal cost for each additional consumer is $0

• by Marginalist Principle, price for non-rival goods should be set at $0 (MPC=MPB)

• Private firms not making profits, unwilling/unable to provide the good

-> no effective supply of the good

How non-excludability (in consumption) leads to market failure

"free-rider problem"

• No incentive to pay

• Each consumer will seek to "free-ride" by allowing others to pay

• Nobody willing to pay (even if they want to consume)

• No effective demand

• Concealed demand would lead to zero provision ("what to produce")

Result of no effective demand (non-rivalry) & no effective supply (non-excludability)

public goods are non-marketable

no private firm wants to undertake production

non-provision leads to market failure

Govt intervention for public goods

direct provision:

• Goods are produced by government or private enterprise and are provided free to the public.

• Tax revenue are used to finance the production.

Example: National Defence (Govt) & Street-lighting (Private enterprise)

Advantages & Disadvantages of direct provision

Advantages:

• Since Govt is producing the public good, they can ensure output maximises net social benefit

Disadvantages:

• Govt must have the funds to implement, else there may be an opportunity cost (divert expenditure from other areas to fund)

• Govt may not produce at its lowest possible cost as they are not motivated by profits