“Market” Failure and the Role of Government

CIA4U: Economics
Unit 3: Firms, Markets and Economic Stakeholders
Video Introduction - “Market Failures”
● As you watch the video consider the following questions
and record your answers on the lesson document
○ What are some examples of where it is appropriate for
government to intervene in free markets? Why?
○ What type of good would you classify primary and
secondary education as?
○ Based on your answers above, how can we most
efficiently distribute this good in society
 Recap:

★ Open competition between firms and “free markets” can

work well for certain goods, but can create inefficiencies in
others.

★ This offers an argument for governments to take action

sometimes to improve the welfare of the economy.
★ The “type” of good or service offers important insights into
whether government should intervene or not
 Goods and their characteristics..

★ Free markets can efficiently provide goods if they are:

1. Excludable
- Producers can prevent people who don’t pay
from consuming the good.
2. Rival in consumption
- The good cannot be consumed by more than
one user at the same time.

★ These are called private goods!

 Goods and their characteristics..
★ However, some good are:
1. Nonexcludable
- Producers can’t prevent people who don’t
pay from consuming it.
2. Nonrival in consumption
- More than one person can consume the unit
at the same time as another.

★ These are called public goods.

Why markets can supply ONLY private goods efficiently...

★ Markets can provide goods efficiently only if:

■ No one firm has market power.
■ There are no externalities.

★ Excludability is crucial here:

■ A farmer could either produce no wheat or provide it
to everyone, regardless if they are willing to pay.
■ No reasonable farmer will pick the second option.
■ A paying consumer is necessary to ensure production.
 Goods and their characteristics..
★ Also, some goods can be considered:
1. Common resource
- Nonexcludable, but rival in consumption.
(Ie. can’t stop someone from drinking from a lake, but when
you drink a portion, no one else could drink that amount)
- Example: clean water
2. Artificially-scarce good
- Excludable, but nonrival in consumption
- Can limit access, but everyone can watch
at the same time!
- Example: Netflix.
 However, in the case of PUBLIC GOODS

★ Consider our sewer system example:

■ It makes a city healthier and cleaner.
■ No rational consumer would pay for it if they can’t be
excluded from the benefits (the “free-rider problem”).
■ In this case, self-interest cannot ensure that production
of this good will be efficient in a free market.
■ Societies need to find non-market means of producing
and distributing this type of good.
 Options for Distributing Public Goods
1. Voluntary contributions
- Donations and private financing
- Does not ensure sufficient funding for some goods.

2. Supplied by self-interested parties

- Some firms provide goods for their benefit, like broadcast (over the air)
TV programs.
- Can diminish the quality of the good, raises questions about
intention/biases. (ex. Excessive advertising)

3. Social Pressure: Volunteer service (difficult as community grows)

 Examples of Public Goods

★ Disease prevention: When diseases are removed, no one

can be excluded and one person’s health doesn’t prevent
another from being healthy.

★ National defence

★ Utilities and infrastructure

■ Examples: roadways, electrical power
 Common Resources
★ Examples:
■ Clean water and air
■ Biodiversity resource (animals, plants)

★ Suffer from the problem of overuse, since they are nonexcludable,

but rival in consumption (more for me means less for you).

★ “Tragedy of the Commons”

 How to manage common resources
1. Tax its use.
- Example: carbon tax on pollution, highway tolls

2. A system of tradable licenses for the right to use the resource:

- Examples: fishing licenses, carbon emissions trading

3. Regulate access - making the resource excludable.

- Assign property rights to some individuals.
- Gives incentive to people to protect the resource.
- Examples: Parks and roads.
 Artificially-scarce resources

★ Examples often include information goods (such as computer

software, music and movies).

★ Markets will exist to provide them since they are excludable,

which allows producers to earn a profit by charging for access.
 Artificially-scarce resources

★ Consumption is artificially low because:

■ marginal cost to society (the extra cost of providing each additional unit
of output) is effectively zero.
○ Think about a Netflix movie, whether 10 people or 1,000,000
watch it, the total cost of providing it effectively doesn’t change.

■ If a producer wants to produce an efficient (profit-maximizing) output,

they have to set price (marginal revenue) = marginal cost.
○ Remember: profit-maximizing level of output (ie. the best) is where
marginal cost = marginal revenue.
○ In this case, this would suggest price has to be zero, but that’s not
realistic for these goods….
 Discussion Questions
1. What type of “good/service” did you categorize education as?

2. Do you believe education should have more private options or a

strong(er) public option?

3. Is the need for education changing for the 21st century economy?

4. Which stakeholder(s) hold the greatest priority in this issue?