Market Failure

<aside> 💡 Market failure happens when the market/price mechanism fails to allocate scarce resources efficiently or when the operation of market forces leads to a net social welfare loss (e.g: health, waste of time)

Market failure occurs when the way prices and markets doesn't do a good job of sharing scarce resources well, or when how markets work causes a loss in overall social benefits, like in people's health or wasting time.

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Causes of Market Failure: M-FAILED

Missing Market:

• Public goods: Goods that are non chargeable(can’t make people pay for it) as it is non excludable and non-rivalry

• Non excludable: goods and services that don’t allow people to own in privately

• Examples: Public parks, and street lighting

• Non rivalry: One consumption will not reduce the availability to others

<aside> 💡 Due to the characteristic mentioned above, private firm is unlikely to provide public goods as they are non chargeable and they cant make profit from providing it.

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Factor Immobility (difficult to move around):

Geographical immobility:

• Refers to the inability of workers to transfer one geographical area to another, this could be due to it being hard to relocate, family or transportation

Occupational immobility:

• Refers to the inability of workers to change one job to another due to lack of skill

Asymmetry Information：

• Information not available to certain groups of people

Income inequality:

• Gap between rich and poor are large

Lack of Competition:

This will give rise to monopolies, which means that they could abuse market power by charging higher prices

Low income group might not be able to afford it

Can run inefficiently as lack of competition will result in lack of motivation to improve

This will affect product quality and reduce cost of production

Externalities:

Social cost: Private cost + external cost

• Private cost: Negative impact on those who are involved in economic activities

• External cost/the spillover effect = Negative impact on third parties that are not involved in economic activities

Social benefit: Private benefit + external benefit

• Private benefit: Positive impact on those who are involved in economic activities

• External benefit: Positive impact on third parties that are not involved in economic activities

Demerit and Merit Goods:

Demerit Goods: Goods and services that bring external cost

• It is overproduced and over consumed as firms and consumers are not fully aware the cost from consuming it

Merit Goods: Goods and services that bring external benefits

• It is underproduced and under consumed as firms and consumers are not fully aware of the benefit of consuming it

Measures to Correct Market Failure: MMLTS (MyMassiveLaTS)

Maximum Price:

• It is the highest price that can be charged by the producer and this highest price will be set below the equilibrium by the government

• The purpose is to prevent the monopoly from changing high price

• Also, it is used to protect the low-income group and make the goods and services especially the necessity more affordable

Disadvantages of Maximum Price:

• The price set by the government is below equilibrium level

  • At such a low price, supply will be low as it is not profitable to produce

  • However, the demand is high due to low price, this will lead to shortages and not everyone will be able to purchase it

Minimum Price:

• It is the lowest price that can be charged by the producer and this lowest price will be set above the equilibrium by the government

• Its purpose is the protect the producer, especially the agriculture producer, to guarantee the producer with certain amount of revenue

  • Also, it is used to increase the price for demerits goods, so to discourage the consumption of demerits as producer cannot sell below a certain price level

Disadvantages of Minimum Price:

The price is set above equilibrium level, this will lead to excess supply because at such high price, supply will increase but there will be low quantity demand hence the government will need to spend money to ur up the excess sully, which will lead to opportunity cost.

Laws and Regulations:

• The government can intervene by making it so producers may not charge above a maximum price or below a minimum price

Taxation:

• The government will place tax on demerit goods so they take into account external costs

• On goods with inelastic demand, the price change will not affect it that much and consumers

Subsidies:

• The government offers subsidies to encourage production of merit goods so they take into account external benefits

Nationalisation vs Privatisation

Nationalisation

• Change of ownership from private sector to public sector(government owned)

| Advantages | Ensures resources are allocated to merit goods/public goods

Ensure fewer resources are allocated to demerit goods | Resources are used to produce goods and services of a high quality

Low cost methods of production are used, less waste of resources

Higher levels of productivity and therefore more output gets produced in less time | | --- | --- | --- | | Disadvantages | If Firums know the government is paying, they have no incentive to keep costs down

State owned enterprises may lack expertise to complete projects on time

Time consuming decision making | The firm may be a monopoly and therefore have less incentive to sell at low prices

Resources will be wasted

Resources may be over-allocated to demerit goods and under-allocated to merit goods | | Sources of income | Taxation - This depends on the willingness of consumers to pay, rates in other countries, income of the country and the reactions of firms and workers to tax changes

Privatisation - Raises revenue in the short term but if the asset was profitable

Borrowing from overseas - this will depend on the governments ‘credit worthiness’ at home and abroad | Profits - This will depend on how profitable the business is

Loans - This will depend on the firms ‘credit worthiness’ and size |

Privatisation

• Change of ownership from public sector and private sector