Market Failure

• Market failure


  Occurs when market forces of demand and supply are unsuccessful in allocating resources efficiently and cause external costs or benefits
• Private costs


  The actual costs of a firm, individual or government
• External costs


  The negative side-effects of production or consumption incurred by third parties for which no compensation is paid
• Social costs


  The true (or full) costs of consumption or production to society, i.e. the sum of private costs and external costs
• By the end of this chapter, students should be able to define the concept of market failure, explain the causes of market failure, and discuss the consequences of market failure
• Market failure occurs when the production and/or consumption of a good or service causes additional positive or negative side-effects to a third party not involved in the economic activity
• Situations that may arise in a free market

  • Education and healthcare services are only provided to those who are willing and able to pay
  • Street lighting and public roads are underprovided
  • Tobacco, alcohol and gambling are overprovided
  • Extraction of oil and construction of office buildings cause environmental damage
  • Monopolists can abuse their market power
• Private benefits


  The benefits of production and consumption enjoyed by a firm, individual or government
• External benefits


  The positive side-effects of production or consumption experienced by third parties for which no money is paid
• Social benefits


  The true (or full) benefits of consumption or production, i.e. the sum of private benefits and external benefits
• Private costs are the actual costs of an individual firm, household or government
• External costs are the negative spillover effects of production or consumption incurred by third parties for which no compensation is paid
• The true cost of an economic activity is called the social cost
• Social cost


  Private costs + External costs
• External costs


  • Air pollution caused by fumes from a factory
  • Noise pollution from a nightclub
  • Cigarette smoke
  • Advertising clutter
  • Litter
• Social benefit = Private benefit + External benefit
• Public goods


  Goods and services that are non-excludable and non-rivalrous, causing market failure due to lack of profit motive
• Demerit goods


  Goods or services which when consumed cause negative spillover effects in an economy
• The existence of monopoly markets can cause market failure
• Factor immobility


  Occurs when it is difficult for factors of production to move or switch between different uses or locations
• Types of factor immobility

  • Geographical immobility
  • Occupational immobility
• Geographical immobility occurs when it is difficult to move a factor of production from one geographical location to another
• Occupational immobility occurs when it is difficult to move a factor of production from one type of work or job role to another
• Deepwater Horizon disaster occurred

  20 April 2010
• Over 240 flights were disrupted in southwestern China due to drones interrupting operations at Chongqing Jiangbei International Airport
• BP estimated that total damages from the Deepwater Horizon disaster would cost the firm $42 billion
• According to Greenpeace, Brazilian supermarkets have banned the sale of meat produced from animals raised in rainforests