ecawns market failure

-VE EXT AND PETDQQD (+ve and -ve)

what is market failure

failure of the free market to allocate resources efficiently

-ve ext?

spillover costs to third parties who are not directly involved in the consumption/production of the good or service itself

MEC

additional cost to third parties (con/prod) ++ unit of g/s

MSC

MPC + MEC

MSC>MPC

over allocation

ext (PETDQQD) P

priv benefit and cost

ext (PETDQQD) E

externalities → what isit

ext (PETDQQD) T

third parties - who?

ext (PETDQQD) D

divergence

—> presence of MEC/B create divergence between MSC/B and MPC/B
—> (MSC><MPC)
—> diagrammatically, MS curve lie above MP by amt of ME
—> assuming no ( ) ext, MP=MS

ext (PETDQQD) Qp

left to free market, firms prod/consumers consume Qp units
MPB=MPC, only consider priv costs and benefits

ext (PETDQQD) Qs

-social optimal lvl of prod/cons = Qs units
- msb=msc
- QP>QS, over production/consumption + over allocation of resources
-QP<QS< under

ext (PETDQQD) Dwl

Deadweight loss

• at Qp, MSC>MSB/MSB>MSC

• add more to costs/benefits

• from Qp to Qs units, TSC>TSB/ TSB>TSC

• welfare loss to society when output not prod at social optimal lvl

• market failure —> Qp is allocative ineff, social welfare NOT maximised

ext (PETDQQD) conc

• ext costs/benefits not factored in decision making

• distortion of price signals

• price mech fail to bring socially optimal allocation of resources

• over allocation

(Govt Int) —> -ve ext (4)

1. indirect taxes

2. rules and regulations

3. tradable pollution permits

4. key SG transport policies

-ve ext: indirect taxes (use)

generate ext costs on third parties

make prod/con internalise the -ve ext

-ve ext: indirect tax —> for producers (8pt)

1. levy indirect tax = MEC @ QS (social opt)

2. increase in MPC, force producers internalise MEC to third parties

3. increase shift of MPC curve by amt of tax (MPC to MPC’)

4. new QP’ (mpc=mpc’) coincide with QS (msb=msc)

5. fall in prod from Qp to Qp’ —> eliminate dwl

6. reduce -ve ext —> incentivise both con and prod to reduce + internalise

7. allocative eff

8. social wf

-ve ext: indirect tax —> consumers

govt levy

1. thru producers —> pass to consumers in terms of higher prices

2. directly at consumers

indirect tax —> govt unintended conseq

1. opp cost of implementation

2. inequity (PED)

indirect tax —> govt intended conseq

1 . revenue from tax (address ext damages from prod/cons of g/s)

2. loss aversion (pain of losing > pleasure of gaining)

indirect tax —> govt limitations (4)

info gap

high admin costs —> unsustainable in long term

uncertainty and time lag

sunk cost fallacy

indirect tax —> govt limitations - info gap

over/under est of MEC

-over: govt levy excessively high tax

• mpc higher than msc

• wf loss >gi

• govt failure

-under:

• tax rate lower than necessary

• new mpc lower than msc

indirect tax —> govt limitations- high admin

manpower and resources (monitoring)

indirect tax —> govt limitations- time lag

-govt need time to determine amt of ext costs

-prod and con need to fully respond to the dis incentives

indirect tax —> govt limitations- sunk cost

time and money alr invested, too much to quit

-ve ext - rules and regulations (types) 3

1. quota

2. ban

3. production/consumption methods

-ve ext - rules and regulations - quotas

def: legal limits on output/pollution lvl

1. set at QS (prevents c/p beyond that lvl)

2. yay allocative eff

for pollution:

1. limit amt of emissions

2. directly limits ext cost generated

3. red mec and msc

4. qs increase, reduce extent of overproduction and wf loss

-ve ext - rules and regulations - bans

2 types

mechanism

complete + partial

def: output quota set at 0

1. def

2. social optimal when MEC very large

3. MSB intersect MSC —> social opt qty QS @/close to 0

4. no prod/cons

5. eradicate all -ve ext + benefits generated from p/c of g/s

6. area A: wf loss (MSB>MSC for output between 0 and Qs)

7. A<B (initial wf loss)

NOTE: better to ban when extent of MEC vv large —> social welfare improves overall

-ve ext - rules and regulations - productn/consumptn methods

1. ext cost decrease

2. social optimal qty QS increase to QS1

3. closer to Q- (QSQP to QS1QP)

4. reduce extent of overconsumption and dwl

5. increase allocative eff

-ve ext - rules and regulations

-ve ext - rules and regulations - govt considerations - limitations

info gap

—> govt dk lvl of penalty/consequence harsh enough to deter firms

—> bans: mec not significant

high admin costs —> unsustainable

—> inspection, monitoring, prosecution

-ve ext - rules and regulations - govt considerations - unint conseq

1. high costs to firms

(firms incurring increasing pollution abatement costs —> same limit on emissions as lower ones)

2. trade off with macroeconomic aims

   (chase firmsaway to other countries cuz penalty too harsh)

3. opp cost of implementation

-ve ext - rules and regulations - govt considerations - intended con

1. laws compel ppl to take action

2. certain and faster outcomes

-ve ext: tradable pollution permits (def)

govt issue firms with permits on max lvl of pollution they are allowed to emit (set quotas)

→ firms buy and sell to eachother in carbon market

-ve ext: tradable pollution permits - example

European Union Emissions Trading System (EU ETS)

—> cap and trade principle

—> price det by mkt dd and ss of such permis

1. pollution abatement costs exceed current permit price

   —> cheaper to buy more permits than reduce pollution lvl

2. firms facing lower pollution abatement costs

   —> sell permits + reduce pollution

-ve ext: tradable pollution permits - outcome

1. cleaner production techniques

2. avoid increase cop, yay revenue

3. ext cost reduced

4. msc shift downwards towards MPC in long run

5. reduce DWL

-ve ext: tradable pollution permits - govt considerations - limitations

1. info gap

2. high admin costs

3. increased pollution in certain regions

—> one region buy permit from another

—> lower non material SES

-ve ext: tradable pollution permits - govt considerations - unintended conseq

1. trade off with macro aims

2. opp cost

-ve ext: tradable pollution permits - govt considerations - unintended conseq - trade off

-need purchase permits

—> increase firm COP

→ decrease in investment, employment and econ growth

—> if heavy polluting firms find permits to costly, might relocate

-ve ext: tradable pollution permits - govt considerations - unintended conseq - opp cost

• increase admin cost outweigh benefit from reducing extent of mf (govt failure)

• opp cost: implementation and enforcement financed thru reduction of spending in other areas

• wf loss for 1 market > wf gain for other market —> GOVT FAILURE

-ve ext: tradable pollution permits - govt considerations - intended conseq

incentives (r&r no incentive to futher reduce emissions once they meet the limit by govt)

lower total cost

more certain outcome

key sg transport policies - govt int (2)

target problem on market of road usage

target problem of rising car ownership

key sg transport policies - govt int - road usage

reduce congestion and pollution —> TAXES

electronic road pricing (ERP)

diagram;

1. indirect tax=MEC @ Qs

2. increase MPC by amt of indirect tax

3. increase cost of road usage, motorists compelled to internalise ext

4. mpc shift to mpc’, traffic vol reduced to Qs, decrease congestion

5. decrease amt of emissions, decrease pollution

6. @Qs, dwl eliminated

7. allocative eff (MSB=MSC)

key sg transport policies - govt int - rising car ownership

reduce congestion and pollution

quota: vehicle quota system (VQS)

tax: additional registration fee (ARF)