Notes on Market Failures from 'How Markets Fail'

Market failure occurs when the allocation of goods and services by a free market is not efficient.
Various forms of market failures exist, including monopoly power, externalities, public goods, and information problems.

Case study: Polar Bears
- In 2004, four polar bears drowned in the Beaufort Sea while swimming to land due to melting ice caused by climate change.
- Increased average temperatures since the 1950s have led to a significant retreat of ice that polar bears depend on for hunting seals.
- Mortalities among polar bears illustrate how climate change results in ecological and market impacts.
The Stern Report (2006) highlights climate change as a significant market failure that presents economic risks similar to major wars or depressions:
- It raises concerns over food supply, health, and access to land and water.
Calls for policy intervention have arisen to address the externalities of carbon emissions, which are viewed as negative spillovers affecting future generations.

Definition of Externalities:
- Externalities are costs or benefits incurred by third parties who are not involved in an economic transaction.
Negative Spillovers:
- For example, a power plant burning coal emits carbon dioxide as a byproduct, without facing penalties for pollution, leading to greater ecological harm.
Pigovian Taxes:
- Economist Arthur Pigou argues for government intervention through taxes to align social costs with private costs.
- Suggested taxes on carbon emissions can incentivize a shift towards cleaner energy sources.

Public Goods:
- Defined as non-rivalrous and non-excludable, meaning one person’s use does not prevent others from using them.
- Examples include national defense, clean air, and public parks.
Market Failure in Public Goods:
- Private markets under-provide public goods due to the free-rider problem, where individuals benefit without paying.
Government intervention becomes necessary to ensure adequate provision of these goods.

Hidden Information:
- Akerlof's “Market for Lemons” illustrates how information asymmetry in the used car market can lead to adverse selection, where the presence of bad quality leads to market failure.
- Risks of this type of failure also exist in labor markets, insurance, and finance, where one party has more information than the other.
Moral Hazard:
- Occurs when insured parties take on riskier behavior because they do not bear the full consequences of their actions, leading to higher costs for insurers.

Need for Government Action:
- Without governmental measures, markets may not function efficiently due to the above failures.
Potential Solutions:
- Implementing Pigovian taxes, regulations, or creating public goods can address inefficiencies in the market.
- Example: Medicare provides coverage for those who might be excluded in a private market due to high risk (hidden information).

Recognizing and responding to market failures is crucial for sustaining economic welfare.
Efforts to correct these failures must balance economic incentives with public good provisions and regulatory oversight to mitigate adverse outcomes in health care, environment, and economic stability.