MICRO: Market Failure

• Market failure


  When the free market fails to allocate resources to the best interests of society, so there is an inefficient allocation of scarce resources
• Economic and social welfare is not maximised where there is market failure
• Types of market failure


  • Positive externalities
  • Negative externalities
  • Merit goods
  • Demerit goods
• Externality


  The cost or benefit a third party receives from an economic transaction outside of the market mechanism
• Externalities can be positive (external benefits) or negative (external costs)
• The extent to which the market fails involves a value judgement, so it is hard to determine what the monetary value of an externality is
• Demerit goods


  Goods that are over-provided due to imperfect information about the long term implications of consuming the good
• Merit goods


  Goods that are under-provided due to imperfect information about the long term benefits of consuming the good
• Not all products that result in positive or negative externalities in consumption are either merit or demerit goods
• Geographical immobility of labour

  Obstacles which prevent labour from moving between areas
• Occupational immobility of labour


  Obstacles which prevent labour from changing their use
• Public goods


  Non-excludable and non-rival goods that are underprovided in a free market because of the free-rider problem
• Private goods


  Rival and excludable goods
• Information gaps lead to a misallocation of resources
• Imperfect information


  Consumers and producers do not have perfect information when making economic decisions
• Symmetric information


  Consumers and producers have perfect market information to make their decision
• Asymmetric information


  Unequal knowledge between consumers and producers
• Principal-agent problem


  When the agent makes decisions for the principal, but the agent is inclined to act in their own interests, rather than those of the principal
• Information could be made more widely available through advertising or government intervention
• Labour market flexibility


  How willing and able labour is to respond to changes in the conditions of the market
• Factors affecting labour market flexibility


  • Trade union power
  • Regulation
  • Welfare payments and income tax rates
  • Training
  • Infrastructure
  • Housing
• The more freedom firms have to hire and fire workers and the more freedom workers have in terms of their rights, the more flexible the labour market
• If welfare payments are generous and income tax rates are high, labour market flexibility is likely to be lower
• More widely available training opportunities and a more skilled workforce makes the labour market more flexible
• Improving infrastructure and making housing more affordable might help the geographical immobility of labour
• Geographical immobility


  The difficulty or reluctance of workers to move to different locations or regions for employment opportunities. Factors such as high housing costs, lack of affordable transportation, or strong social and family ties can contribute to geographical immobility.
• External mobility


  The ease with which workers can move between different jobs or industries, rather than geographical locations. External mobility is influenced by factors such as the availability of jobs, workers' skills and qualifications, and the flexibility of labor markets.