Market Failure 1.2

• Market failure


  A situation in which a market left on its own fails to allocate resources efficiently

  
  

  if good is over consumed or under consumed

  
  

  5 types:

  Lack of Public Goods

  Under-supply of merit goods

  Over-supply of demerit goods

  Externalities (4 of them)

  Common Access Resources and Threats to sustainability (Use of Fossil fuels)

  
• Allocative efficiency


  A state of the economy in which production is in accordance with consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to society equal to the marginal cost of producing it

  
• Lack of public goods

  goods that are of benefit to society, the lack of public goods in a free market would be considered market failure
• Public goods


  A good or service that is characterized by non-rivalry and non-excludability; a good or service with these characteristics would not be provided in a free market (market failure) and are therefore provided by the government. eg flood barriers, national defense

  
• Quasi public goods


  public goods that could debatabely exist in a free market (e.g. street lighting, light house)
• Non rivalrous


  2. non rival- the consumption of the good by one person does not keep other people from also consuming that good.
• Non excludable


  impossible to exclude individuals from consumption
• Government intervention with public goods


  1. may provide the good themselves (use taxpayer money)

  2. subsidize companies to produce good
• Under Supply of Merit Goods

  lack of consumption of a good that has a positive benefit to society = market failure
• Merit goods


  goods that would be under-provided in a free market economy (e.g. healthcare and edu, health facilities, the opera). goods the government thinks have benefits to society

  
  

  all public goods are merit goods
• Government intervention with Merit Goods

  1. depending on important government will attempt to increase supply and thus consumption, if the good is very important (edu and healthcare) the government may subsidize it completely/provide directly, if less important than subsidized left

  
  

  all subsidies paid by tax payer's anyways
• Over supply of demerit goods


  over consumption of goods with a negative effect on society = market failure
• Demerit goods


  goods that will be over-provided by the market and, because of this, will be over-consumed. goods that the government thinks are bad for both people and society, and thus will attempt to decrease consumption (e.g. smoking, alcohol, child pornography, junk food, hard drugs)
• Government intervention with demerit goods


  attempt to decrease consumption by:

  1. if really important they will make illegal or ban (e.g. hard drugs and child pornography)

  2. if less important they will tax it (cigarettes and alcohol)
• Externality


  A cost or benefit of a good or service that is not included in the purchase price of that good or service (to a third party)

  
• Marginal private benefit


  The extra benefit or utility to the consumer of consuming an additional unit of output.

  
• Marginal private cost


  the cost of producing an additional unit of a good or service that the consumer of that good or service received.

  
• Marginal social cost


  The extra cost to society of producing an additional unit of output, including both the private cost and the external costs.
• Marginal social benefit


  The extra benefit or utility to society of consuming an additional unit of output
• MPC


  essentially the private supply curve that is based on the firms costs of production
• MPB


  essentially the private demand curve that is based on the utility or benefits to consumers
• Negative Externality


  A 'bad' cost imposed without compensation on third parties by the production or consumption of sellers or buyers. eg. effects of smoking on third party

  
• Welfare loss


  loss of economic welfare because of a decrease in producer or consumer surplus; occurs when a market is not in equilibrium
• Negative Externality of Production (External Costs)

  when the production of a good or service creates external costs that are damaging/harmful spill-overs to third parties (e.g. pollution from factories)
• Government intervention for Negative Externality of Production

  1. Tax the firm to shift supply line to desired allocative efficient quantity. if externality fixed = internalized

  (problems with taxing: hard to measure pollution, hard to place monetary value on pollution, tax no reduce pollution)

  2. Government could legislate/ban (pass laws regulating output) problems: may lead to job loses and non consumption of valuable product, and may be expensive to police law

  3. issue tradable emission permits
• tradable emission permits


  licenses to emit limited quantities of pollutants that can be bought and sold by polluters (AKA Cap and Trade)

  
• cap and trade scheme


  A scheme in which a government authority (of a single country or group of countries) sets a limit or 'cap' on the amount of pollutants that can be legally emitted by a firm, set by an amount of pollution permits distributed to firms; firms that want to pollute more than their permits allow can buy more permits in a market, while firms that want to pollute less can sell their excess permits.

  
• carbon taxes


  A tax on fossil fuels (especially coal and gasoline) based on their emissions of CO2 and other air pollutants.

  
• Negative Externality of Consumption

  when goods consumed create a harmful spillover effect to third parties (e.g. second hand smoke, pollution)
• Gov Intervention with Negative Externalities of Consumption

  1. Ban the good. Problem: most these goods addictive, and getting addicts to vote against may be hard to do)

  2. Place partial ban instead (regulating where smoking is allowed)

  3. Tax the good (shift supply line to meet allocative efficient quantity supplied) problem: if product is inelastic, tax will not reduce consumption (perk: great income for government), but it may deter non addicts, and if taxes are too high = emergence of black/foreign markets

  4. provide edu/advertise against the good, problem: costly and may only effect in long run
• Positive externalities


  a benefit obtained without compensation by third parties from the production or consumption of sellers or buyers. Example: A beekeeper benefits when a neighboring farmer plants clover. An external benefit or a spillover benefit.

  
• Potential welfare gain


  gain in economic efficiency that could occur if production or consumption can be increased to the pareto optimal level of output (MSB = MSC)

  
• Positive Externalities of Production (External Benefits)


  when production of good or service creates external benefits that are good for third parties (e.g. employee training, ecotourism)
• Government Intervention Positive Externalities of production

  1. Subsidize. problems: expensive and difficult to estimate value of subsidy needed, and subsidy = opportunity cost)

  2. provide vocational training (in the case of employee training) problem: expensive and may not work, but great effect on PPC and economy
• Positive Externality of Consumption


  when the consumption of a good or service provides an external benefit to third parties (e.g. school, healthcare, use of deo)
• Government Intervention Positive Externalities of Consumption

  1. Subsidize or provide completely. problem: very expensive, developing countries no afford,

  2. advertise to increase consumption. problem: high cost and may be more effective long run than short run, must weigh out benefits)

  3. pass laws insisting on use. problem: infringement of civil liberties
• Direct provision


  (a governmental arrangement) government provides a public service directly

  
• Sustainable development


  Development that meets the needs of the present without compromising the ability of future generations to meet their own needs.

  
• Tragedy of commons


  states that individuals acting independently and rationally according to each's self-interest behave contrary to the best interests of the whole group by depleting some common resource
• Sustainable Development Threats


  MARKET Failure!

  1. poverty

  2. fossil fuels

  3. green house gases