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Free market
price mechanism determines the most efficient allocation of scarce resources (factors of production: land labour capital entrepreneurship)
Market failure definition
An inefficient/ less than optimum allocation of resources, from societies point of view. There is a lack of allocative efficiency.
consumer surplus is not maximised, failure of market to produce at marginal social cost = marginal social benefit
Causes of market failure
externalities, public goods, common pool resources
marginal private benefit
Benefits received by those who produce or consume a product.
or: “The additional benefit received from the consumption or production (output) of one additional unit of output”
marginal social benefit
The total benefit to society from producing or consuming a good / service.
It includes all the private benefits plus any external benefits of production / consumption.
or “The benefit to society received from the consumption or production (output) of one additional unit of output. It is the sum of the private benefits plus the external benefits”
marginal private cost
Private cost of an activity to an individual economic unit
Marginal social cost
The total cost to society of the production or consumption of a product including private cost and negative externalities.
Socially optimum output
marginal social benefit (MSB) = marginal social cost (MSC)
no market failure
negative externalities of production
market is failing due to over-provision of goods/services as only the private costs are considered by the producers and not the external costs. harmful effects on third parties
social costs of producing a good are higher than private costs.
negative externalities of consumption
market is failing due to over-consumption of goods/services as only the private costs are considered by the consumers and not the external cost
social benefits are less than private benefits
demerit good
goods which have external costs in consumption deemed to be bad for the individual and society as a whole but would be over consumed if left to the free market
positive externalities of production
market is failing due to under-provision of these goods/services as only the private benefits are considered by the producers and not the external benefits
production would cause benefit to third party
positive externalities of consumption
market is failing due to under-consumption of these goods/services as only the private benefits are considered by the consumers and not the external benefits
merit good
goods and services which are deemed to be good for individuals and society as a whole but would be under consumed if left to the market
common pool resources
non excludable, rivalrous
add if needed
tragedy of the commons
sustainability definition
meeting the needs of the present without compromising the ability of future generations to meet their needs.
unsustainability
resources used faster than they can be replenished
indirect tax
placed on a product with harmful side effects (demerit goods)
make the individual or firm causing the externality to pay for it
can be placed on negative externality of production or consumption (both shift the supply curve)
evaluation of indirect tax
causing externalities pays
reduce quantity of demerit goods (more efficient allocation of resources
reduce external costs
raises govt revenue
however
depends on PED
illegal markets
output falls due to higher prices, may have to lay off workers
carbon taxes
tax on producers who emit green house gases
pay for each ton of carbon dioxide (CO2) emissions
raises cost of production, decreases supply
evaluatating carbon tax
increases cost of production for firms
reduces external costs
encourage firms to consider investing in pollution abatement technology
raises government revenue
however
effectiveness depends on ped
firms unable to pay will leave market
lay off workers due to high prices
subsidies
grants paid by the government to producers to lower cost of production (Normally on Merit Goods)
shifts supply curve to the right
usually when there is positive externality of consumption
legislation and regulation
Legislation aimed at the consumer side:
shifts demand curve to the left (demand +legislation)
such as limited drinking age
aimed at producer: shifts supply to the left
evaluation of legislation
can be targeted
reduce external costs
fines generate govt revenue
however
hire more people for regulation
difficult to determine whether law is being broken
illegal markets
unpopular with large companies and voters
education
raising awareness of external benefits and costs
shifts demand for merit or demerit good
evaluating education
changes mpb
amount spent on education is less than that spent on externalities
positive cultural changes
over time improves economic development
however
takes long time to change behaviour
opportunity cost
demerit goods are usually addictive
merit goods are usually expensive
evaluation method
challenges involved in measuring externalities
degree of effectiveness of the solution (big problems are hard to deal with, need multi-faceted approach
impacts on different stakeholders
tradable pollution permits
cap and trade scheme
governments allocate a suitable level of pollution
each permit typically valid for the emission of one ton of pollutant
firms that pollute more need to buy more
additional cost of production therefore reduction in supply
if costs of permits is higher than costs of investing in non polluting technology, creates incentive for firms to switch
international agreements
adress negative externalities
focus on: common pool resources, environmental challenges, global trade in demerit goods
evaluating international agreements
reduction in welfare loss is greater when countries work together
resources can be pooled
interdependence
however
more economically developed countries try and enforce agreements which reduce use of “dirty technology”
no legal consequences from withdrawing from international agreements
new political parties can tr and change agreements
collective self governance
when stakeholders in a community work together to combat negative externalities, usually associated with common pool resources
evaluating collective self governance
creates common purpose
community knows best how to manage resources
create employment opportunities
eco sustainable tourism
however
disagreement
taking back control from corporations can be violent and difficult
works better when there are private property ownership rights
government provision
merit goods and public goods are usually under-provided
not provided by private firms due to free rider problem
governments end up providing
evaluating government provision
free at point of consumption
accessible to everyone
private and external benefits
however
paid through taxation
opportunity cost
excess demand (waiting time at hospitals)
public good
non excludable and non rivalrous
under provision
government intervention: government provision, nothing, contract out (pay company to provide good/service)
policies for emissions from use of fossil fuels
legislation and regulation, indirect tax on output, carbon tax, tradable permits, education (taxes and tradable permits cause incentive, others do not)
policies to reduce demerit goods
legislation and regulation, education, indirect tax
policies for unsustainable use of common pool resources
collective self governance, etc
policies for positive production externalities
subsidies, government provision, education
policies for positive consumption externalities
legislation and regulation, advertising, education, direct government provision, subsidies.
Evaluating tradable pollution permits - Challenges
Difficult to accurately calculate the total level of CO2 emissions produced by firms, leading to a potentially misleading allocation of permits. The initial number of permits issued is based on these calculations, and if the calculation is too high, it results in an oversupply of permits, rendering them ineffective in reducing pollution.
Evaluating tradable pollution permits - Effectiveness
While these permits can be an effective method for decreasing the overall quantity of emissions, thus helping mitigate welfare loss, their effectiveness heavily relies on proper initial calculations and government oversight to ensure compliance.
Evaluating tradable pollution permits - Market impact
Larger firms often have greater financial resources to buy more permits than smaller firms, which may struggle to acquire sufficient permits for their emissions. This disparity can lead to market imbalances and potentially create monopolies where larger companies dominate the market.
Evaluating tradable pollution permits - Price impact
If the demand for permits remains inelastic (meaning that supply changes do not significantly affect demand), firms are likely to pass on the increased costs of permit acquisition to consumers in the form of higher prices for goods and services.
Evaluating tradable pollution permits - Technology shift
In response to the costs associated with purchasing permits, some firms may opt to invest in new technologies that reduce emissions, thereby decreasing their need for permits and potentially leading to lower overall pollution levels.
Evaluating tradable pollution permits - Market dynamics
While some firms might strategically leave the market due to the financial burden of purchasing permits, others may relocate their operations to countries with less stringent environmental regulations, leading to potential 'pollution havens'.
Evaluating tradable pollution permits - Consumer effect
The increased costs incurred by firms from purchasing permits can result in higher prices for consumers, which may lead to reduced consumer spending or changes in consumption patterns as people seek more affordable alternatives.
