MARKETS, EFFICIENCY, AND PUBLIC POLICY

Conditions for markets to work well:

-Private property - the rights to the thing bought/sold

-Institutions e.g. government - enforcing property rights

-Social norms – respecting property rights

-Ability to write complete and enforceable contracts that can be evaluated in a court of law

When do Markets fail?

When property rights are missing, incomplete, or are difficult to enforce with a contract.

Causes of market failure under perfect competition

-External effects

-Asymmetric information

-Incomplete contracts

Possible solutions of market failure

Private bargaining and government policies

What is an externality?

An effect of an economic decision that is not specified as a benefit or liability in the contract

Negative external effect formula

MSC > MPC

What is pareto efficient level

Price = Marginal Social Cost

What are the solutions to an externality

Bargaining and compensation

How does solution: Bargaining work

-Legally assign property rights to the externality (e.g. the right to pollute, the right to clean air)

-Private bargaining between parties involved will result in a Pareto-efficient allocation regardless of which party has the property rights, in the absence of transaction costs.

-May be more effective than government intervention because private parties have more of the necessary information.

-However, transaction costs (costs of acquiring information, enforcing the contract, or collective action) can be a major obstacle in reality.

Will private bargaining between parties lead to Pareto-efficient allocation?

Yes