market failure

• Market failure= price mechanism leads to misallocation of resources
• negative externalities: costs that affect 3rd parties outside the price mechanism
• Example of consumption negative externalities:

  • alcohol leading to vomit on road
• 3 characteristics of negative externalities:

  • PC+PB are inside price mechanism
  • EC is outside PM
  • social cost = PC+EC
• Negative externalities = overproduction of demerit goods
• net benefit = social benefit - social costs
• In negative externalities of production: MPC is more than MSC as production is cheaper
• negative externalities= overproduced and consumed= welfare loss= gov intervene with indirect tax
• For gov intervention to succeed = right size of tax = negative externality internalised
• Example of negative externalities:

  • pollution
  • deforestation
• Negative externalities: market equilibrium output is greater than socially efficient output
• positive externalities: benefits to 3rd parties as a result of actions of consumption
• Examples of positive externalities:

  • healthcare
  • education
  • exercise
• subsidy= money grant for firms by the government to reduce cost of production increasing output
• subsidy increases revenue
• Subsidy effect on customers:

  • more choice
  • more affordable
  • consumer surplus
• Subsidy effect on producers

  • increase supply
  • revenue maximisation
• pollution permit steps

  1. cap from gov
  2. permits
  3. more firms= more permits
  4. trade between firms on permits
• in positive externalities:


  SB>PB
• Pure public goods


  non-rivalry and non excludable
• Public goods


  problem: Free riding problem no demand = decrease in supply= under provided
• How are public goods made?

  direct + indirect tax = tax rev= public goods
• Quasi goods?


  public goods sometimes
• The tragedy of the commons?

  natural public goods used for sustainability are non-rivalrous goods= benefit all

  common are rival goods

  natural resources get depleted
• Information gaps 


  lack of information needed to make informative decisions
• Incomplete information def:


  someone don't have full information about the benefits or costs of their decisions
• gov intervention for incomplete information

  1. regulation
  2. provides information
  3. subsides
• Asymmetric information def


  when one party knows more than another party in a transaction
• asymmetric information


  misallocation of resources= MARKET FAILURE
• merit goods example

  • positive externalities
  • information gaps
• merit goods= UNDER- CONSUMED
• demerit goods are OVER-CONSUMED
• demerit goods?

  1. negative externalities
  2. information gaps
• monopoly power leads to market failure= exploitation of consumers
• occupation immobility: workers cannot move in between jobs due to lack of skills= labour market failure= structural unemployment
• Gov intervention for occupational immobility:

  Education, training and apprenticeships
• Geographical immobility of labour?

  Workers struggle to work in-between jobs physically
• Gov intervention of geographical immobility?

  transportation and relocation subsides
• equitable= fair
• equal: equal