Transcript Market Failure - PowerPoint Presentation

2.4
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Market Failure
Market Failure
Definition:
 Where the market mechanism fails to
allocate resources efficiently
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Social Efficiency
 Allocative Efficiency
 Technical Efficiency
 Productive Efficiency
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Market Failure
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Social Efficiency = where external costs and
benefits are accounted for
 Allocative Efficiency = where society
produces goods and services at minimum cost
that are wanted by consumers
 Technical Efficiency = production of goods
and services using the minimum amount of
resources
 Productive Efficiency = production of goods
and services at lowest factor cost
Market Failure
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Allocative efficiency:
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Also referred to as
Pareto Efficient Allocation – resources
cannot be readjusted
to make one consumer better off without
making another worse off – zero
opportunity cost!
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After Vilfredo Pareto (1848–1923)
Market Failure
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Market Failure occurs where:
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Knowledge is not perfect - ignorance
Goods are differentiated
Resource immobility
Market power
Services/goods would or could not be provided in
sufficient quantity by the market
Existence of external costs and benefits
Inequality exists
Market Failure
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Imperfect Knowledge:
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Consumers do not have adequate technical
knowledge
Advertising can mislead or mis-inform
Producers unaware of all opportunities
Producers cannot accurately measure productivity
Decisions often based on past experience rather
than future knowledge
Market Failure
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Goods/Services are
differentiated
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Branding
Designer labels - they
cost three times as
much but are they three
times the quality?
Technology – lack of
understanding of the
impact
Labelling and product
information
Which one is the ‘quality’ item and why?
Market Failure
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Resource Immobility
Factors are not fully mobile
 Labour immobility – geographical and
occupational
 Capital immobility – what else can we use
the Channel Tunnel for?
 Land – cannot be moved to where it might
be needed, e.g. London and South East!
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Market Failure
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Market Power:
Existence of monopolies and oligopolies
 Collusion
 Price fixing
 Abnormal profits
 Rigging of markets
 Barriers to entry
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Market Failure
Inadequate Provision:
 Merit Goods and Public Goods
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Merit Goods – Could be provided by the
market but consumers may not be able to
afford or feel the need to purchase – market
would not provide them in the quantities
society needs
 Sports facilities?
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Market Failure
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Merit Goods
Education –
nurseries,
schools, colleges,
universities – could
all be provided by the
market but would
everyone be able to
afford them?
Schools: Would you pay if the state
did not provide them?
Market Failure
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Public Goods
 Markets would not
provide such goods and
services at all!
Non-excludability – Person
paying for
the benefit
cannot
prevent anyone
else from also benefiting the ‘free rider’
problem
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A non-excludable good?
Non-rivalry –
Large external benefits
relative to cost – socially
desirable but not
profitable to supply!
Would you pay for this?
Market Failure
De-Merit Goods
 Goods which society over-produces
 Goods and services provided by the
market which are not in our best
interests!
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Tobacco and alcohol
 Drugs
 Gambling
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Market Failure
External Costs and Benefits
 External or social costs
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The cost of an economic decision to a third
party
External benefits
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The benefits to a third party as a result of a
decision by another party
Market Failure
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External Costs
Decision makers do not take
into account the cost imposed
on society and others as a
result of their decision
 e.g. pollution, traffic
congestion,
environmental
degradation, depletion of
the ozone layer, misuse of
alcohol, tobacco, antisocial behaviour, drug
abuse, poor housing
Externalities
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Private costs and benefits are costs and benefits
that are borne solely by the individuals involved in the
transaction.
An externality is a cost or benefit that accrues to
someone who is not the buyer (demander) or the
seller (supplier).
If externalities exist, it means that those involved in the
demand and supply in the market are not considering
all the costs and benefits when making their market
decisions.
As a result, the market fails to yield optimal results.
Externalities
Externalities are the effect of a decision
on a third party that is not taken into
account by the decision-maker.
 Externalities can be either positive or
negative.
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Negative externalities occur when the
effects of a decision not taken into
account by the decision-maker are
detrimental to others.
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Positive externalities occur when the
effects of a decision not taken into
account by the decision-maker is
beneficial to others.
A Negative Externality Example
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When there is a negative externality,
marginal social cost is greater than
marginal private cost.
A steel plant benefits the owner of the plant
and the buyers of steel.
 The plant’s neighbors are made worse off
by the pollution caused by the plant.
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A Negative Externality Example
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Marginal social cost includes all the
marginal costs borne by society.
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It is the marginal private costs of production
plus the cost of the negative externalities
associated with that production.
A Negative Externality Example
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When there are negative externalities,
the competitive price is too low and
equilibrium quantity too high to maximize
social welfare.
A Negative Externality*
S1 = Marginal social cost
Cost
S = Marginal private cost
Marginal cost
from externality
P1
P0
D = Marginal
social benefit
0
Q1 Q0
Quantity
More on Externalities
A positive externality may result when
some of the benefits of an activity are
received by consumers or firms not
directly involved in the activity.
 A negative externality may result when
some of the costs of an activity are not
borne by consumers or firms not directly
involved in the activity.
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Social Cost
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Social cost: the total social cost of a
transaction is the private cost plus the
external cost.
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If all of the costs of a transaction are
borne by the participants in the
transaction, the private costs and the
social costs are the same.
Externalities and Market Failure
When there is a divergence between
social costs and private costs, the result
is either too much or too little production
and consumption.
 In either case, resources are not being
used in their highest-valued activity and
market failure can occur.
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Negative Externalities
With a negative
externality, the supply
curve does not reflect the
true cost of the good. As
a result, the supply that is
provided is greater than it
would be if suppliers had
to pay all the costs
(including the external
cost). SP is the supply
provided, whereas SS is
the supply as it would be
if the suppliers had to pay
the external cost.
A Positive Externality Example
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Private trades can benefit third parties
not involved in the trade.
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A person who is working and taking night
classes benefits himself directly, and his coworkers indirectly.
A Positive Externality Example
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Marginal social benefit equals the
marginal private benefit of consuming a
good plus the positive externalities
resulting from consuming that good.
A Positive Externality
S = Marginal private and social cost
Cost
P1
D1 = Marginal social benefit
Marginal benefit of an externality
P0
D0 = Marginal private benefit
0
Q0 Q1
Quantity
Positive Externalities
With a positive
externality, the demand
curve does not reflect all
the benefits of the good.
As a result, the demand
that is given in DP is less
than it would be if
demanders received all
the benefits (including
the external one). DS is
the demand as it would
be if the demanders
received the external
benefit.
Pollution Tax
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One class of solutions to the externality problems
involve internalizing the costs and benefits, so
that the market can work better.
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Pollution Tax: if a firm is creating a negative
externality in the form of pollution, create a tax on
the polluting firm equal to the cost of cleaning up
the pollution.
Regulation Through Taxation*
Marginal social cost
Cost
Marginal private cost
P1
Efficient tax
P0
Marginal social
benefit
0
Q1 Q0
Quantity
Pollution Tax
Command
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Another approach is command—rather
than imposing a tax or offering a subsidy,
the government simply requires or
commands the activity.
For a negative externality like pollution,
the government simply requires the
company to stop polluting.
 For a positive externality, like inoculation,
the government requires certain classes of
citizens to be inoculated.
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Marketable Pollution Permits
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Another approach to pollution is the
introduction of marketable pollution permits.
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The government sells the permits, which in total
allow the amount of pollution that the government
believes to be acceptable.
Demanders, typically firms, purchase the permits,
allowing them to pollute up to the amount specified
by the permits they own.
If a firm is able to employ a cleaner technology,
then it can enjoy additional revenues by selling its
pollution rights to someone else.
Subsidy for Inoculations
Market for Pollution Permits
External Costs
MSC = MPC + External Cost
Price
The Marginal Social Benefit
Thedifference
MPCtherefore
does
not is
take
into
TheThe
true
the
MSC
between
the
curvecost
(MSB) represents
the
account
the
cost
to
society
of
MPC
(thevalue
MPC
external
cost).
thethe
MSB
andtothe
MSC
sum ofplus
benefits
production.
At welfare
antherefore
output
level
Current
output the
levels
(100)
represents
loss
consumers
in society
as
a to
of
100,
the
private
cost
to
the
represent
some
element
of
market
society
ofthe
100private
units being
whole –
and social
supplier
is
£5
per
but the
failure
–
price
does
notunit
accurately
produced.
benefits. The Marginal
Private
cost
totrue
society
is
higher
than
reflect
the
cost
of
production.
Cost (MPC) curve represents
this (£12).
costs negative
to suppliers of
Value ofthethe
producing a given output.
£12
Social Cost
£7
£5
externality (Welfare Loss)
Socially efficient output is where
MSC = MSB
MSB
80
100
Quantity Bought and Sold
External Costs
MSC = MPC + External Cost
Price
The Marginal Social Benefit
Thedifference
MPCtherefore
does
not is
take
into
TheThe
true
the
MSC
between
the
curvecost
(MSB) represents
the
account
the
cost
to
society
of
MPC
(thevalue
MPC
external
cost).
thethe
MSB
andtothe
MSC
sum ofplus
benefits
production.
At welfare
antherefore
output
level
Current
output the
levels
(100)
represents
loss
consumers
in society
as
a to
of
100,
the
private
cost
to
the
represent
some
element
of
market
society
ofthe
100private
units being
whole –
and social
supplier
is
£5
per
but the
failure
–
price
does
notunit
accurately
produced.
benefits. The Marginal
Private
cost
totrue
society
is
higher
than
reflect
the
cost
of
production.
Cost (MPC) curve represents
this (£12).
costs negative
to suppliers of
Value ofthethe
producing a given output.
£12
Social Cost
£7
£5
externality (Welfare Loss)
Socially efficient output is where
MSC = MSB
MSB
80
100
Quantity Bought and Sold
Market Failure
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External benefits –
 by products of
production and decision
making that raise the
welfare of a third party
 e.g. education and
training, public transport,
health education and
preventative medicine,
refuse collection,
investment in housing
maintenance, law and
order
External Benefits
There can be a position where
output is less than would be
socially desirable (education
for example?) In this case, the
sum of the benefits to society
is greater than the private
benefit to the individual.
Price
MSC
Value of the positive
externality (Welfare Loss)
£10
£6.50
Social Benefits
£5
MSB
Socially efficient output
is where
MSC = MSB
MPB
100
140
Quantity Bought and Sold
Market Failure
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Inequality:
Poverty – absolute and relative
 Distribution of factor ownership
 Distribution of income
 Wealth distribution
 Discrimination
 Housing
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Market Failure
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Measures to correct market failure
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State provision
Extension of property rights
Taxation
Subsidies
Regulation
Prohibition
Positive discrimination
Redistribution of income