1.5- The market mechanism, market failure and government intervention in markets

when do positive externalities occur

when production and/or consumption create external benefits on third parties outside of the market

what do positive externalities create

3rd party spillover benefits

what is the result of positive externalities

social benefit of production/consumption is greater than the private benefit

name external benefits of positive externalities

lower costs for other parties, increase revenues for other parties, increased satisfaction for other parties

what are positive externalities associated with

merit goods and services

give 2 examples of positive production externalities

flood defence projects that protect the whole community, projects to reduce deforestation

give examples of positive consumption externalities

healthcare/childcare/flu vaccines, education

give an example of using positive externalities

the decline of public libraries

what are reasons for declining usage of libraries

rise of e-books, libraries are outdated, cuts in local authority funding

what are approaches to increase the use of libraries

sharing of digital network resources, investment in free wifi, national library card

when do negative externalities occur

when production and/or consumption impose costs on third parties outside of the market

give 3 examples of negative production externalities

air pollution from factories, damage to the environment, noise pollution from airline industry

give 3 examples of negative consumption externalities

effects of passing smoking, impact on family life of gambling and alcohol addiction, noise pollution from concerts

compare co2 emissions in 2010 and 2022

2022- 36.5 billion metric tonnes/ 2010- 32.8 billion metric tonnes

how is the externality of carbon emissions been reduced

the EU carbon Emissions trading scheme is a cap and trade scheme which sets a decreasing cap for co2 from energy intensive sectors and allocates or auctions emissions allowances

what has the UK done to reduce carbon emissions

introduced a carbon price floor- minimum price for carbon emission to provide a stable carbon signal

name a major cause of market failure

externalities

how do externalities cause market failure

if the price mechanism does not take account of the social costs and benefits of production and consumption

private cost

costs faced by the producer or consumer directly involved in a transaction

private benefits

benefits for producer and/or consumer directly involved in an economic transaction

how to calculate social cost

social cost= private cost + external cost

how to calculate social benefit

private benefit + external benefit

marginal private cost

cost to the producers producing an additional unit of output

marginal external cost

cost to third parties from the production of an additional unit of output

marginal social cost

total cost to society of producing an extra unit of output- MSC = MPC + MEC

marginal private benefit

benefit to the consumer of consuming an additional unit of output

marginal external benefit

benefit to third parties from the consumption of extra unit of output

marginal social benefit

total benefit to society from consuming an extra unit- MSB = MPB+ MEB

what are merit goods

goods and services that the government feels that people will under-consume and might be subsidised or made free

what sectors provide merit goods

state and private

what are features of merit goods

rival, excludable and rejectable

what externality do merit goods produce

positive externality- social benefit from consumption exceeds the private benefit

examples of merit goods

health programmes, public libraries, free school meals

why are there rising healthcare demands

ageing population, rising expectations, inequality, growing population

public good characteristics

non-excludable, non-rival, non-rejectable

non-excludable

non-payers can enjoy benefits of consumption

examples of public goods

street lights, flood control systems

non-rival

benefit other people get from the good does not diminish if more people consume the good

free-rider problem

people who do not pay for the good still receive benefits from it. reason for public goods being underprovided by the private sector as they do not make profit from providing the good

why are public goods underprovided

free-rider problem, difficult to measure value consumers get from the good so it harder to price

who provides public goods

the government

how are outputs of public goods decided

gov has to estimate the social benefit of the public good when deciding the output

how are public goods funded

using tax revenue, but quanitity provided will be less than socially optimum quantity

characteristics of a private good

rival and non-excludable

symmetric information

consumers and producers have perfect market information to make their decision. this leads to an efficient allocation of resources

information failure

occurs when people have innacurate or incomplete data and can make potentially ‘wrong choices/decisions’

where can perfect information be found

in competitive markets

causes of information failure

long term consequences, complexity, unbalanced knowledge, price information

examples of information failure

risks from using tanning salons, addiction to painkillers/drugs, gaining entry to elite degree courses

asymmetric information

an imbalance in information between buyer and seller which can distort choices

moral hazard

insured consumers are likely to take greater risks, knowing that a claim will be paid for by their cover

examples of policies addressing information failures

compulsory labelling on products, improved nutritional information, performance league tables

indirect tax

tax imposed by the government that increases the supply costs faced by producers

how is indirect tax shown on a graph

by the vertical distance between the two supply curves

examples of indirect taxes

VAT, sugar tax, alcohol duties

ad valorem tax

imposes tax on a good, depending on its value- expressed as a percentage

regressive tax

imposed by government which takes a higher percentage of someone’s income from those on low incomes

why are indirect taxes used

key source of tax revenue for gov. spending, can be used to change consumer and producer behaviour

explain the plastic packaging tax

taxes plastic packaging manufactured in or imported into the UK and does not contain at least 30% recycled plastic

factor immobility

when a factor of production cannot easily be moved to another area of the economy

reasons for geographic immobility

large house-price, rent and cost of living differences, social ties, imperfect information about jobs available in different areas

occupational mobility

when there are barriers to the mobility of factors of production between different industries

reasons for occupational immobility

1. lack of training, education and skills required to do a different job

2. lack of required qualifications

why does immobility cause market failure

there is a misallocation of resources

how to reduce geographical immobility

rise in house building, gov. relocation of subsidies/ mortgage relief

how to reduce occupational immobility

better funding of training, teaching new skills or expansion of apprenticeship/internship programmes

how is inequality caused

wage differences, discrimination, regressive taxes

how is inequity a cause of market failure

people do not have income and wealth to pay for things they need

how is inequity a consequence of market failure

free market leads to inequitable distribution of income and wealth with misallocation of resources

subsidy

any form of government support offered to producers to reduce the marginal cost of supply

what do subsidies lead to

an increase in the output sold of a good or service at a lower market price

examples of gov. subsidies

solar panels, wind farm investment, steel manufacturing

examples of gov subsidies to consumers

people buying electric vehicles, food and energy subsidies

disadvantages of subsidies

producers can become ‘subsidy dependent’, distort resource allocation, excess production/ surpluses

maximum prices

legally imposed maximum price in a market that suppliers cannot exceed

aim of maximum prices

improve affordability of a good or service to consumers especially those on lower incomes

examples of maximum prices

rent controls (e.g. in portland oregon in 2020), utility price caps

minimum price

legally imposed price floors mostly associated with minimum hourly wage rates

examples of minimum price

minimum wage in the UK, minimum unit pricing (scotland introduced minimum price of alcohol in 2018)

examples of state provided goods

education and healthcare

benefit of state provided goods

makes merit goods more accesible, increasing their consumption and create positive externalities

what are regulations

rules enforced by an authority to try to reduce market failure and its impacts

why is regulation used

to reduce the use of demerit goods and services, reduce the power of monopolies, increase consumption of merit/demerit goods

examples of regulatory failures

limit innovation, capping prices could prevent new firm from entering a market, technology

what does provision of information provide

• gov. can ensure there is no information failure

• consumers can make more informed decisions

how is regulation enforced

• gov. could use laws to ban consumers from consuming a good

• gov. could make it illegal not to do something

• e.g minimum school leaving age is 18

• this has positive externalities in the form of a higher skilled workforce

when is there gov. failure

• when gov. intervenes in markets

• they could worse the market failure already present or a new failure

• this results in a net welfare loss

what does distortion of price signals mean

occurs when factors outside of supply and demand leads to inefficient resource allocation e.g subsidies, price controls and taxes

how does distortion of price signals create gov. failure

• gov subsidies could distort price signals

• this distorts the free market mechanism

• could lead to gov. failure

• as there is an inefficient allocation of resources because market mechanism is not able to act freely

what are unintended consequences

This is when the actions of producers and consumers have unexpected, or unintended, consequences

when does unintended consequences take place

with gov. policies, consumers react in unexpected ways

what are excessive administrative costs

• costs outweigh the social benefit of administering the policy

• It might cost more than the government expected

how can information gaps be solved

using a cost-benefit analysis but this is time-consuming and expensive

why are there information gaps

it is impractical for governments to gain every bit of information they need, so assumptions are made

what is the rationing function

price mechanism that refers to how prices allocate scarce resources when demand exceeds supply

give an example of the rationing function

• a good is scarce so price increases

• discourages some customers from buying it

• makes sure that the available quantity is sold only to those willing and able to pay higher prices

• rationing the scarce product to those who will value it most

what is allocative efficiency

optimal allocation of resources to produce goods and services that meet consumers needs