market failure

• what is an externality?

  the effect of an economic decision that occurs outside of the market (positive and negative effect)

  • they affect third parties which are not directly involved
  • they exhibit the free-rider problem
• classifying externalities

  external costs = negative externalities - when production and consumption impose external costs on third parties such as passive smoking, acid rain and air pollution

  external benefits = positive externalities - when third parties benefit from spill over effeet of production and consumption such as education and training and vaccination programs
• private and social benefits and costs

  social benefit = private benefit + external benefit

  social cost = private cost + external cost

  • positive externalities occur when social benefit is greater than private benefit
  • negative externalities occur when social cost is greater than private cost
• example of negative externalities in production

  pollution generated by a factory that imposes costs on others
• example of positiive externalities in production

  companies developing new technologies that benefit themselves and other companies, leading to lower costs for other firms
• example of negative externalities in consumption

  where the consumption of a demerit good leads to adverse consequences for third parties (passive smoking)
• examples of positive externalities in consumption

  where the consumption of a merit good generates benefits for third parties (vaccinations)
• how can the government reduce Negative externalities?

  Regulation and Taxation
• what are public goods?

  non-rivalry so consumption by one person does not reduce the supply available for others

  non-excludability meaning that the benefits derived from them cant be confined solely to those who have paid for it

  • though this leads to the free rider problem
• examples of pure public goods

  flood defences, vaccinations and national parks
• private goods

  excludable so sellers can prevent people who haven paid from consuming it

  pricing and profit so private goods are priced in markets based on supply and demand and consumers pay for what they consume
• examples of private goods

  priavte gyms, tickets to an event and meals in a restaurant
• why are public goods financed by the government?

  non-excludability so taxation ensures that everyone contributes tot he funding of the public goodtherefore preventing free-riders

  economies of scale, so taxation allows gov to collect funds from broad tax base which is more cost effective.
• quasi public goods

  its a near public good, it has some characteristics of a public good so theyre semi-non-rival as some goods can become crowded due to high consumption such as public wifi and semi-non-excludable such as fencing a park or beach and charging an entrance fee
• examples of quasi public goods

  crowded beaches and free wifi
• the free-rider problem

  leads to under-provision of a good and thus causes market failure

  • tax evasion
• merit goods

  goods and services the government think people will under-consume, and which might be subsidised or made free

  • information failure is an aspect of merit goods, they can be rival, excludable and rejectable

  consumption of merit goods creates positive externalities where SB exceeds SC, a merit good is a good that society values and judges that people should all have
• examples of merit goods

  education, vaccinations, clean energy and public libraries
• information failure and long short term

  merit goods are under-consumed because the benefits arent fully understand

  demerit goods are over-consumed because the effects arent fully understood
• demerit goods

  goods which are believed to have negative externalities on society which arent fully recognised by the person consuming them, meaning they have spill over effects in society

  so in the absence of a government intervention these goods would be over-consumed
• examples of demerit goods

  high caffine energy drinks, violent games and films, alcohol fraud
• demerit goods and value judgements

  demrit good are judged about the harm they cause to individuals and society

  these judgements are based on societal normas an ethical considerations which involve value judgements
• demerit goods and imperfect information

  information gaps, individuals not being aware of long-term effects and benefits of certain goods

  misleading advertisement, consumers may underestimate the harm it causes
• maximum prices

  its an attempt to prevent market price from rising above a certain amount, to be effective max price needs to be set below the free market price
• minimum prices

  the min price needs ti be set above the normal equilibrium price in order to be effective
• black markets

  they develop where there is excess demand for a commodity

  • tickets for major events
• how can governments intervene?

  in extreme cases they can abolish the market and replace it with a command or planned economy, influence market behaviour by providing more info

  They can also impose regulations and taxes + subsidies
• causes of geographical immobility

  famility ties, language barriers, high costs of commuting
• income

  the flow of earnings to a factor of production over a period of time

  wealth is a stock of owned assets
• regulations

  promote positive externalities
• market replacement

  completely banning negative externalities and demerit goods
• government failure

  occurs when intervention by gov to correct market failure makes matter worse

  • leada to a further misleading of resources