Market Faliure

Market Failure occurs when the free market fails to allocate sacre resources at the socially optimal level of output

Why it happens.

Negative externalities - self interest

Positive externalities

De - merit Goods - information failure

Merit Goods

Public Goods - Free rider problex /

Common Access resources - self interest

Income inequality - inequality

Monopoly power - one dominant seller

Factor Immobility

Negative externalities in production

1) cost to 3rd parties as a result of the actions of producers

Examples air pollution, Residents suffer from air pollution, they are the 3rd party. Resource depletion, resource segregation, deforestation

2) Marginal Social cost > Marginal production cost. Social cost = PC + EC

What to say about negative externalities?

Firms are ignoring social cost because of their self interest as a result there is over production/consumption. The price is also too low, it is only accounting for the private cost and not the full social cost. So their is a misallocation of resources. Allocative efficiency

Negative externalities in consumption

1) Cost to third parties as a result of the actions of consumers

Examples - Smoking, Excessive alcohol

2) Marginal social Benifit < Marginal private Benifit

Positive Externalities in consumption

1) Benefits to 3rd parties as a result of consumption

Examples - Healthcare, education, exercise, healthy eating

2) Marginal social benefit > Marginal private Benefit

Consumer are only interested in their Self interest

Under consumption

Misallocation of resources

Positive externalities in production

Benefits to 3rd partied as a result of the actions of producer

Examples - in work training

MSC < MPC

Policies to alleviate externalities

Fixed limite on the activity, internalise the externality by imposing a cost on the party creating the externality, tradeable pollution permits allow firms which can reduce pollution relatively cheaply to do most of the adjustment, other firms can then buy this firms surplus permits

Merit goods - Goods deemed more beneficial to consumers then they realise

Imperfect information to consumers

Examples - Healthcare, education, exercise (People might not understand how beneficial these stuff are)

Irrational decision made by consumers It might lead to under consumption and produced in a free market.

Positive externalities in consumption - MPB<MSB

De Merit goods

Goods deemed more harmful to consumers than they realise

Imperfect information

Negative externalities in consumption

Over consumed / produced

Public Goods

Pure public goods are

Non excludable - no price can be charged for a public good because

The benefit of the good cannot be confined to the individual

There is no efficient way to price

Non - rival - the quantity of good doesn’t diminish upon consumption

Examples - street light, beaches, roads

Free Rider problem - doesn’t pay, wait for other to pay

Common access resource

Natural resources over which no private ownership has been established.

Lack of private ownership leads to the tragedy of the commons.

It is when private producer keep exploiting common access resources until the resource depletes. They act in their own self interest.

Government failure

When the cost of intervention outweighs the benefits of the intervention.

The end result is a worsennig of the allocation of source resources harming social welfare.

1) information failure - valuing externalities, the right level of policy required

2) Admin and enforcement costs very high - regulation, subsides, state provisions , price controls all have high cost

3) unintended consequences - Black markets,

4) Regulatory capture - when regulating monopoly power

Indirect taxation increases a firms cost of production but can be transferred on to consumers.

NE in production

What would an indirect tax do to the diagram, for example a carbon tax

Increases cost fof production, - shifts the mpc curve to the left to make it perfect aligned with msc.

By doing so we internalise externalities

Solves overconsumption/prodution

Promotes allocative efficient whilst generating government revenue.

But price inelastic demand, setting tax at right level, regressive, black markets

Ne in consumption

Increases firms cost of production - shift the mpc curve to the left.

Indirect tax has the same pros and cons as Ne in production

Regulation to solve market failure

Rule/Law enacted by the government that must be followed by economic agents to encourage a change in behaviour

Non market based approach to solve market failure.

It commands/control approach

Bans, limits, caps, compulsory, strong enforcement and effective punishment is needed

Incentive to change behaviour

Solve issues in free market

Allocative efficiency and welfare gain

However it is expensive, problem with setting the right regulation, Black markets might appear, and it might be unfair on some firms

Long term equilibrium in a market is when each producer makes an economic profit of 0. People are not entering or leaving the market.