Market failures occur when the free market fails to allocate resources efficiently. There are several types of market failures: externalities, public goods, asymmetric information, and abuse of monopoly power. Externalities occur when the actions of producers or consumers impact third parties without compensation. Government policies aim to correct market failures through regulations, taxes/subsidies, information provision, and direct provision of goods/services.
Market failures occur when the free market fails to allocate resources efficiently. There are several types of market failures: externalities, public goods, asymmetric information, and abuse of monopoly power. Externalities occur when the actions of producers or consumers impact third parties without compensation. Government policies aim to correct market failures through regulations, taxes/subsidies, information provision, and direct provision of goods/services.
Market failures occur when the free market fails to allocate resources efficiently. There are several types of market failures: externalities, public goods, asymmetric information, and abuse of monopoly power. Externalities occur when the actions of producers or consumers impact third parties without compensation. Government policies aim to correct market failures through regulations, taxes/subsidies, information provision, and direct provision of goods/services.
Too many/few goods & services are produced and consumed from the POV of what is socially most desirable. Marginal Benefit (MB) ≠ Marginal Cost (MC) Externalities
Externalities occur when actions of producers or
consumers give rise to negative/positive side effects on 3rd parties, whose interests are not considered. If side effects are beneficial for the 3rd parties, it is called positive externality (spill-over benefit.) If side effects are harmful or detrimental then it is called negative externality (spill-over cost.) Marginal Private & Social Costs & Benefits Private costs & benefits are the costs & benefits to producers & consumers that produce & consume the goods & services. Social costs & benefits are the costs & benefits to all of society (non-producers/consumers) from the consumption/production of goods & services. Social costs & benefits = Private costs & benefits + externalities Graphs
Demand curve is marginal private
benefit (MPB) curve. Supply curve is marginal private cost (MPC) curve. When there are no externalities: > D = MPB = MSB > S = MPC = MSC Negative Production Externalities
MSC is higher than MPC because there
are some negative externalities associated with the production of the good/service. Vertical difference between MSC & MPC is the social cost. Demerit goods have negative externalities. Correcting: - Government regulations - Market based policies (indirect taxes & trade/cap schemes) Correcting Negative Production Externalities Negative Consumption Externalities
MSB is lower than MPB because there are
some negative externalities associated with the consumption of the good/service. Vertical difference between MSB & MPB is the social cost. Demerit goods have negative externalities. Correcting: - Government regulations - Advertising (awareness) - Market based policies (indirect taxes) Correcting Negative Consumption Externalities Positive Production Externalities
MSC is lower than MPC because there
are some positive externalities associated with the production of the good/service. Vertical difference between MSC & MPC is the social benefit. Correcting: - Direct government provision - Market based policies (subsidies) Correcting Positive Production Externalities Positive Consumption Externalities
MSB is higher than MPB because there
are some positive externalities associated with the consumption of the good/service. Vertical difference between MSB & MPB is the social benefit. Merit goods have negative externalities. Correcting: - Legislation/advertising (awareness) - Direct government provision - Market based policies (subsidies) Correcting Positive Consumption Externalities Lack of Public Goods
Private goods are rivalrous & excludable:
- Rivalrous is when consumption by someone reduces availability for others - Excludable means it is possible to exclude some people from consuming a good. Usually achieved through charging a price for it. Public goods are non-rivalrous & non-excludable. Free rider problem. Correcting failure to provide public goods: - Direct government provision Common Access Resources & threats to Sustainability Common Access Resources are resources that are not owned by anyone and can be used by all for free. Examples are clean air & forests. Failure occurs in that use by one leaves less for others. They are rivalrous & non-excludable. Sustainability refers to the ability to be maintained & preserved over time. Maximum Sustainable Yield of Common Access Resources Government Responses to threats to Sustainability Legislation: - licenses - quotas - permits - restrictions Carbon taxes vs Cap & trade schemes - Carbon taxes are methods to reduce emissions - Cap & trade schemes are tradeable permits Funding clean technologies Eliminating environmentally harmful subsidies Asymmetric information
Refers to situation where buyers & sellers do not have equal
access to information. Seller knows of a defect in a product but doesn’t inform customers. Buyer knows about sickness but doesn’t tell insurance provider. Government responses: - Regulation - Provision of information - Licensure Abuse of monopoly power
Monopoly power is the market structure where 1 firm
dominates the market for a product/service & is able to control prices. It is a failure because: - welfare loss - allocative inefficiency - productive inefficiency Government responses: - Legislation - Regulation - Nationalisation - Trade liberalisation