market failure and externalities

• Taxes on polluting activities, such as green taxes, carbon taxes or congestion charges, can be used by governments to discourage firms from engaging in environmentally damaging practices.
• The government can use taxation to reduce the level of pollution.
• Market failure means a less than optimum allocation of resources from the POV of society, hence linked to inefficient allocation of resources in the free market.
• The government may intervene in markets due to market failure which could be caused by:

  • externalities
  • lack of competition
  • missing markets
  • lack of information
  • factor immobility
• Externalities: Sometimes firms do not consider all the costs of production. Any damages done to people or things outside the business due to this activity is an external cost. For example, a firm pollutes the air during production and does not pay for the damages (people getting sick etc.), external cost = poor air quality
• Lack of competition: The lack of competition in a market can lead to market failure as the market gets dominated by one or a small number of firms. The dominant firm/firms may be able to exploit the market by charging higher prices and limiting choices.
• Lack of Information: Lack of information about products and services makes it hard for consumers to make informed decisions. Without enough knowledge, they cannot compare different options and choose the best value for money. As a result, some goods might go unsold while others remain overpriced.
• Missing markets: Public goods are not provided by the private sector and merit goods are unlikely to be provided by the private sector as well due to how expensive they are.
• public goods: goods that are non-excludable, non-rival. These goods including national defence, policing, prisons, streetlights, etc. are provided by the public sector (the government) because if the private sector provides them, it would lead to market failure and the free rider problem.
• free rider problem: When an individual enjoys the benefit of a good or service but is paid by others.
• Private sector: The private sector is usually responsible for providing everyday goods and services such as groceries and durables including food, clothes, cars, electronics etc. It would also include raw materials, components, machinery, and commercial services used by businesses.
• Factor immobility: The factors of production which are enterprise, labour, land, and capital have to be mobile and able to move from one use to another freely.
• The government may intervene in markets by imposing regulations on businesses that impose negative externalities, such as fines for pollution.
• Legislation can be used to prevent businesses from dominating the market, for example, by investigating the intentions of mergers.
• State money can be used to provide merit goods and public goods, which can be provided free of charge by the public sector.
• The government can pass laws to force firms to provide more information about the products.
• The government may be able to help make some factors more mobile such as retraining workers after they lose their previous job.
• social cost: the entire cost of a decision, including both private costs and any external costs

  
  

  social cost = private cost (the money) + external cost (negative externalities)
• private cost: the cost of an economic activity to individuals and firms
• external cost: negative spillover effects of consumption or production. This affects third parties in a negative way
• Private benefit: The reward to individuals or firms of an economic activity
• External benefit: positive spillover effect of consumption or production. This brings benefits to third parties
• demerit goods: goods that are harmful to consumers or society, for example, alcohol or tobacco. These goods could be overconsumed or overproduced.
• subsidies: a government payment to support businesses in attempt to make them produce more
• privatisation: the act of selling a company or activity controlled by the government to private investers
• effects of privatisation - consumers: It is hoped that consumers will benefit from privatisation. Businesses are under pressure from the competition to meet customer needs and return profit for the owners. They should be effective and provide good quality products at a reasonable price.
• effects of privatisation - workers: Mass redundancies are very likely to happen after the privatisation of organisations. This causes the companies to weaken and makes it more expensive to scale up in the future. In addition, workers may be forced to work more productively such as being forced to adopt more flexible working practices.
• effects of privatisation - businesses: Firms are left without government interference and will have to face competition. These firms will be affected in different ways.

  • Profit becoming a significant objective, increasing the profit
  • Increased investment following privatisation
  • A lot of mergers and takeovers
  • Firms and businesses have diversified into new areas
• effects of privatisation - government:

  Pro:

  Governments can benefit from privatisation by the huge amount of revenue generated. Also, once the government is no longer responsible for running companies, it can focus more on the business of goverment

  Con:

  However, due to the expensive cost of advertising each sale, the government may be criticised by taxpayers who contributes to this money. Also, when some state assets were sold off too cheaply, the government failed to maximise the revenue
• diversified - increasing the range of goods or services a firm produces
• hostile takeover - takeover where the company being taken over does not agree to
• takeovers - getting control of a company by buying over 50% of its shares
• reasons for privatisation:

  • to generate income
  • public sector organisations were inefficient
  • reduce political interference
• spillover effects - effect that one situation has on another situation
• External cost examples:

  • noise pollution
  • air pollution
  • water pollution
  • overcrowding
  • traffic congestion
  • resource depletion (using up)
• External benefits examples:

  • education - people can do highly skilled/useful jobs -> higher productivity and living standards -> lower unemployment, improve house mobility -> benefits the wider society
• External benefits examples:

  • health care - people being more healthy ->work more effectively-> contribute to economic output and pay taxes -> benefits wider society
• External benefits examples:

  • vaccinations - more individuals are given vaccinations to prevent infection -> lower likelihood for people who did not get vaccines contracting disease (bc number of people who might pass on the disease is reduced)
• Social benefit: The total benefit of a decision, including the private benefits and any external benefits

  social benefit = private benefit (the money/satisfaction)+external benefit(positive externalities)
• Government policies to deal with externalities (part 1):

  • taxation - reduce external costs of production and consumption (eg. high taxes on chemical firms producing harmful emissions -> price up and demand falls)
  • subsidies - offering money (subsidies/other financial rewards) to firms to reduce external costs. Giving subsidies to good things (university/solar power) to encourage people to do them.
  • fines - imposed on those who damage the environment