Market Failure and Govt. Intervention

Pre-Conditions for a competitive market

• Strong competition between buyers and sellers in the market

• Firms are price takers, no firms have significant market power

• Homogenous products

• Consumer sovereignty guides how resources are allocated

• Perfect knowledge for buyers and sellers

• Sellers/resource owners aim to maximize profit

Market Failure

Occurs when the price system allocates resources inefficiently, reducing the overall satisfaction of society’s wants, wellbeing and living standards

Examples of Government Intervention

• Indirect taxes

• Subsidies to encourage consumption or production

• Various laws

• Education/informative advertising

• Min/Max prices

• Policies that promote competition

Abuse of market power

In markets with oligopolies and monopolies it is likely sellers will restrict competition, lift prices and reduce efficient resource allocation. This leads to a reduction in the general satisfaction of society

Government intervention to fix abuse of market power

1. Deregulation of key markets to promote competition

2. Creating import tariffs and liberalising trade

3. Laws to promote price competition and regulate monopolies

Asymmetric Information

Asymmetric information refers to when buyers lack complete/accurate information required to make rational decisions about how to allocate their resources(money)

Government fixing asymmetric information

1. Laws about full disclosure

2. Informative advertising and educational campaigns

Negative externalities

• Costs paid or borne by third parties arising from the production or consumption of a good or service

• Example, smoking causes an indirect cost on a third party as taxpayers have to fund the public health system

• This leads to a misallocation of resources as products that reduce society’s wellbeing/living standards are produced

Positive externalities

• Benefits received by a third party that arise from the production or consumption of certain goods or services.

• Examples include vaccinations and education

• Market failure occurs when these products are underallocated

Govt. intervention to reduce negative externalities

1. Laws

2. Indirect taxes

3. Subsidies

Govt. intervention to increase positive externalities

1. Provide socially desirable govt. services(Eg. Public healthcare)

2. Educational advertising

3. Subsidies

Public goods

• Are particular products or services that can be consumed by an individual with preventing others from accessing it, and nobody is excluded from using it

• Non-excludable and non-rivalrous

• Examples: Street lighting, police, national defence

• Issues arise with public goods when they are under-allocated by producers

Government intervention to increase public goods

1. Use the govt. budget to provide these items

Non-excludable

Anyone can use it without paying

Non-rivalorous

One person using it does not prevent another from using it

Excludable

You have to pay to use/ gain access to it

Rivalrous

One person using or buying the product prevents another from

Common access resources

• Natural resources such as air, minerals, oil, forests and wild fish

• Non-excludable but rivalrous

• Issues arising from common access resources are inter-temporal efficiency

Govt. intervention for Common access resources

1. Paris agreement

2. Reduction of deforestation

3. Laws against overfishing

Positive externality of Consumption. Social benefits vs Private Benefits

Social benefits outweigh private benefits

Positive externality of production. Social vs Private costs

Social costs are less than private costs

Negative externality of consumption. Private vs Social benefits

Private benefits outweigh social benefits

Negative externality of production. Private vs Social costs

Private costs are less than social costs