Econ 101(8X)

Lecture #7
September 30, 2021
Return Qz#1
Market Failure
Week after next: Monday (Oct 11)
• Canadian Thanksgiving (Holiday)
• Instead, Monday’s class will be on Tuesday, Oct 12 (Regular Tuesday
classes will be cancelled)

• Join Zoom: Special Tuesday Meeting (Thanksgiving)

• Time: Oct 12, 2021 08:00 AM Vancouver
• https://columbiacollege.zoom.us/j/68145627357
Qz #1 Results – First feedback
• Course Grades: Final 35%, Midterm • Section 081 Results: 23.8/50
25%, Quizzes (4) 10% each (Total 15 tests)
• Second Chance: I will only count 3 best
quizzes for 40% of your mark • 45+ 0
• Average this quiz 28.4/50 (Total 25 • 40+ II
tests)
• 35+ III
• 50 – I
• 45+ IIIII
• 30+ I
• 40+ II
• 35+ III
• 30+ III
New (on portal)

• 1. Reading Material #4 Answers to Quiz #1

• 2. Reading Material #5 Adam Smith vs Market Failure
• 3. Working Sheet #3 Problem Session on Market Failure
(for next class)
 • Demand curve is supposed to reflect how people value a
good
• Supply curve is supposed to reflect what other
opportunities are available for the resources used to
produce a good
• Equilibrium quantity is the amount of the good that is
valued MORE than other potential uses (next best uses) of
the good. So producing the equilibrium quantity of a
Why interfere product is using resources wisely. It is using scarce
resources to produce what consumers want the most.

with the • So, how do we get to equilibrium? By listening and

reacting to prices. An equilibrium price is a “resting point”

market? --- when prices aren’t at equilibrium, someone can make

profits by moving the price closer to equilibrium by
moving resources to where there is a more valuable use.
In other words when P≠ Pe there are still gains from trade
that a smart person can capture for themselves and move
the economy to a more efficient use of resources.
• Adam Smith’s “invisible hand” – Self interest of consumers
and producers creates prices (and profits) directing
resources to their best use
 Equilibrium Floor Change
CS ABC A -BC
PS DEF BDF B-E
Blocking Total Gains ABCDEF ABDF -CE

prices (with
ceilings/floors
) creates waste
(DWL)
So why is there so much interference in the market?
• Milk Marketing Board --- limits who can sell milk to local grocery
stores, limits how much milk each producer can sell, sets price that
producers earn for their milk
• Minimum Wage Laws --- The British Columbia government
raised the minimum wage to $15.20 an hour, June 2021
• Tax on Alcohol – In BC, provincial sales tax on alcohol is 10% but this
is only 14.4% of the total taxes on alcohol (Stockwell, et al Alcohol
Pricing in Canada, UVic, 2006) meaning total taxes on alcohol are
69.4% of producer’s price)
• Subsidies for electric cars in BC: A provincial rebate of up to $3,000
is available to help with the up-front cost of an electric vehicle,
which can be combined with other federal rebates for as much as
$8,000 in savings
Three theories (to explain interference)
• 1. Advocates of interference don’t understand economics and believe
in “free lunch”, Santa Claus and magical thinking….
• 2. Advocates of interference don’t care about the overall economy or
society but only their friends (if a ceiling helps me, I want it, even if it
cause great damage to many others)
• 3. Perhaps D and S are incorrect. Consumers may overestimate
(cigarettes?) or underestimate (green vegetables) the value of
products. Producers may not see all the costs (pollution?) or may
overestimate costs (new technologies) in their decision to produce a
good. If D or S are incorrect, the market is not giving actors the
correct information about the best use of resources and needs to be
corrected. Advocates of this idea are called “Public Interest”
economists and their claims rely on an idea called “market failure”.
• Deirdre McCloskey
• https://www.deirdremccloskey.c
om/docs/pdf/McCloskey_Empty
EconomicBoxesRevisited.pdf
(108 market failures arguments)
• We’re only going to look at three
types of “market failures” this
semester:
• 1. The true value is less than the
perceived value (the good is a
“bad”) i.e. cigarettes, alcohol,
gambling etc.,
• 2. The true cost to society is
higher than the cost that
suppliers pay out of their own
pocket (pollution)
• 3. Suppliers have “market
power” that they use to capture
extra profits from consumers
(monopoly)
Analyzing a “bad” (cigarettes)
• The True demand (people’s true
feelings) is less than the visible
demand (how people act)
• Peer pressure, addiction, failure to
understand the long run
consequences
• Because this consumer is weak
(lacks self control), he buys the
equilibrium amount, but wishes he
was strong enough to resist
temptation and buy a smaller
amount
• What is the TRUE consumer surplus at
the equilibrium quantity?
• True value=ACEFG, Consumer
Expenditure=CDEFGH, True CS=A-DH
• Some of the cigarettes purchased are still
truly worth more than what the
consumer pays (A), but some of the
cigarettes he buys, he regrets. Because
for some cigarettes, the price he pays is
higher than his true valuations of those
cigarettes (DH). The consumer is saying,
“Please help. I’m weak. I truly wish I
wasn’t buying so many cigarettes.”
• At equilibrium: True CS=A-DH, PS=CDE,
True Total Gains=ACE-H
• What if we help this person out, by
bringing in a price ceiling at Pc?
• This reduces the Qtraded to Qt
• At Qt, True value=ACEF, Consumer
Expenditure=EF
• True CS=AC, PS=E, True Total Gains=ACE
• In this case the price ceiling has
INCREASED the total gains to society
• The price ceiling has eliminated H (the
DWL caused by allowing the consumer
to buy too many cigarettes)
 Analyzing pollution (producers aren’t reacting to True cost) – bad smell from mushrooms

• The True supply (the true cost to society) is above the

supply curve that affects producers (the visible supply)
• Driver of a car doesn’t pay for emissions that uses up
other people’s air for breathing, factory doesn’t pay
for dirt in water emissions that affect fish, blue berry
farmers don’t pay for loss of sleep to neighbors
created by noise to keep birds from crops
• The cost paid by the producer is under the visible
supply curve, but the cost to society includes the bad
smell. It is the area under the True supply curve.
• Because the producer doesn’t pay all the cost to
society from his actions, he is over-using resources to
produce this product.
• What is the TRUE producer surplus at the
equilibrium quantity?
• True cost=CDEGHIJ, Revenue=FGHIJ, True
PS=F-CDE
• Some of the mushrooms produced are sold
for a price greater than the True cost to
society (F). But some of the mushrooms
(once we count the cost of the bad smell)
are creating costs GREATER than what
consumers are willing to pay for (CDE).
Society is saying, “Please don’t produce
these mushrooms.” But the mushroom
producers don’t hear these costs and
overproduce what society really wants.
• At equilibrium: True PS=F-CDE, CS=ABCD, True
Total Gains=ABF-E
• What if we help this person out, by bringing
in a price floor at Pf?
• This reduces the Qtraded to Qt
• At Qt, True cost=CGI, Revenue=BCFGI
• True PS=BF, CS=A, True Total Gains=ABF
• In this case the price floor has INCREASED the
total gains to society
• The price floor has eliminated E (the DWL
caused by allowing the producers to produce
too many mushrooms)
 Adam Smith
• Ceilings & Floors reduce Qtraded below Qe
and resources are moved from best use to a
less valued use (DWL)
Public Interest (Market Failure)
• Market can overproduce a product (Tastes
are confused or costs to society not taken
into consideration) Ceilings and floor can
reduce production to its optimal level thus
eliminating the waste caused by the
overproduction and creating a net gain for
society
 The beginning of economic analysis
Public Interest Adam Smith

• If you support a ceiling or floor, do • But how does government know the true
you have good evidence for a market tastes of consumers or the true costs of
certain actions (these valuations are in
failure?
the minds of people and so far,
• Is there some reason, consumers are government can’t read your minds)
confused about taste and you can • Be wary of paternalism (forcing your own
improve their lives by making it more tastes on others). This could prevent
difficult to obtain “bads” or easier to consumers from enjoying what they
obtain “goods”? really want or stop production when
• Is there some good reason that government overestimates damages.
producers are not paying attention to • Also, does the institution called
the real costs of their actions? government really have your interests at
heart?
Adam Smith vs Public Interest
• The models help us understand the arguments being made in favour
of or opposed to interference in the market…..
• But the models don’t measure the true value or true cost. That is
difficult work beyond an introductory course. And subject to lots of
disagreements among good economists.
• The models can’t tell us whether we should interfere… only what
information we need to evaluate if we support or oppose
interference.