Transcript ###Market Failure - PowerPoint Presentation###

MARKET FAILURE
IB ECONOMICS
JANUARY 2012
M. PADULA
QUESTIONS TO CONSIDER
• What is Market Failure?
• Why do we care when the market fails?
• Does price always reflect true costs and true
value?
• Is monopoly bad for society? Always?
• When should government intervene?
Topics in…Market Failure
• Overview—What is Market Failure?
• Externalities
• Positive Externalities (Consumption and Production)
• Negative Externalities (Consumption and Production)
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(Lack of) Public Goods
Common Access to Resources & Sustainability
Asymmetrical Information
Abuse of Monopoly Power
THE MARKET
Tell me again why the market was so great?
(3 minutes at your table)
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THE MARKET
Tell me again why the market was so great?
•Invisible hand as “supercomputer”
•Price Rationing:
• Productive efficiency—output with lowest possible cost
(how to produce)
• Allocative efficiency—goods and services most wanted by
society (what to produce)
•Self-interest  Incentives that promote growth
WHAT IS MARKET FAILURE?
• Sorry Mr. Sowell, the market isn’t perfect
• It fails when the market mechanism, working
freely, fails to allocate resources efficiently:
• Marginal Cost ¹ Marginal Benefit
• Market not providing the optimal combination of goods
and services desired by society
• Market failure is a major justification for
government intervention, which leads to a
prevalence of mixed market economies
• Allocative efficiency: An ideal difficult to realize
MARKET FAILURE
• What does Market Failure look like:
• Under-provision of a good/service, or
• Over-provision of a good/service
• What are the “Classics”?
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Externalities
Merit goods/Demerit goods
Lack of Public goods
Common Access Resources
Asymmetrical Information
Monopoly Power
MARKET FAILURE: EXTERNALITIES
• An externality occurs when the actions of consumers
or producers create positive or negative side-effects
on other people:
• Who are not part of the actions
• Whose interests are not taken into consideration
• Or, when Private Benefits/Costs ¹ Social Benefits/Costs
Positive or
Negative?
Consumption or
Production?
Known as…
1. Negative
Production
Spillover costs
2. Negative
Consumption
Spillover costs
3. Positive
Production
Spillover benefits
4. Positive
Consumption
Spillover benefits
EXTERNALITIES IN ACTION
Price
MPC
Demand = Marginal Benefit
= Marginal PRIVATE Benefit
Supply = Marginal Cost
= Marginal PRIVATE Cost
We normally speak of
“equilibrium” as society’s most
efficient level of output—this
works well when there are no
Externalities
Pe
MPB
Qopt
Quantity Bought and Sold
1. NEGATIVE PRODUCTION COSTS
Spillover Production Costs
• Decision makers do not take into
account the cost imposed on
society and others as a result of
their decision
• Negative Production Costs:
• Pollution
• Environmental degradation
• Depletion of the ozone layer
Excellent news
Smithers…widget
sales are up!
1. GRAPHING EXTERNAL COSTS
MSC = MPC + External Cost
Price
The Marginal Social Benefit curve
The MPC does not take into
(MSB)
represents
the sum
of the
The
true
cost
therefore
the
MSC
account
the costisto
society
of
MPC
benefits
to
consumers
in
society
The
difference
between
the
(the MPC
plus the external
cost).level
production.
At an output
as a whole
–levels
the and
private
and
social
value
of
the
MSB
the
MSC
Current
output
(100)
therefore
of 100, the private cost
to the
benefits.
The
Marginalof
Private
represents
theelement
to
represent
some
market
supplier
iswelfare
£5 perloss
unit
but the
Cost
(MPC)
curve
represents
the
society
of 100
units
being
failure
–cost
price
does
not
accurately
to society is higher than
costs
to suppliers
producing a
produced.
reflect
the
cost ofofproduction.
thistrue
(£10).
given
Value
ofoutput.
the negative
£10
Social Cost
£7
£5
externality (Welfare Loss)
Socially efficient output is where
MSC = MSB (in this case 80)
MSB
80
100
Quantity Bought and Sold
1. GRAPHING EXTERNAL COSTS
MSC = MPC + External Cost
Price
MPC
£10
The MPC does not take into
account the cost to society of
production. At an output level of
100, the private cost to the
supplier is £5 per unit but the cost
to society is higher than this (£10).
Value of the negative
externality (Welfare Loss)
£7
£5
Socially efficient output is where
MSC = MSB (in this case 80)
MSB
80
100
Quantity Bought and Sold
1. CORRECTING NEGATIVE
PRODUCTION EXTERNALITIES
How can the government correct these externalities?
Goals: Bring MPC closer to the MSC, reduce output to Qopt
•Legislation/Regulation: Legally forbid polluting activity, or
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Impose limits on allowable pollution
Limit the quantity that can be produced
Require polluting firms to install technology to limit/eliminate pollution
In all cases, goal is to limit production bring the MPC closer to the MSC
•Impose a tax on the firm’s production of the good
• Target the tax to equal the spill-over cost
•Tradable permits
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International body issues permits
Firms can buy or sell based on Supply and Demand
Incentive for firms to find ways to reduce externality—they can sell permits
See page 163
2. NEGATIVE CONSUMPTION COSTS
Spillover Consumption Costs
• Decision makers do not take into
account the cost imposed on
society and others as a result of
their decision
• Negative Consumption Costs:
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Misuse of alcohol, tobacco
Anti-social behaviour
Drug abuse
Driving using fossil fuels
A party with loud music late at night
Yeah so I
smoke…de
al with it!
2. GRAPHING EXTERNAL COSTS
Price
MSC=MPC
Socially efficient
output is where
MSC = MSB (in this
case Qopt)
Pm
Spillover Cost
Popt
MPB
MSB = MPB - Spillover Cost
MSB
Qopt Qm
Quantity Bought and Sold
2. CORRECTING NEGATIVE
CONSUMPTION EXTERNALITIES
How can the government correct these externalities?
Goals: Bring MPB closer to the MSB, reduce output to Qopt
•Advertising/Persuasion (ant-smoking campaigns, PSA’s)
• Decrease demand, bring MPB closer to MSB
•Legislation/regulation
• Anti-smoking laws
• Curfews
• Public trash cans
•Taxing the firm that produces the good
• Increases the MPC so high that Qm moves to Qopt
• Price increases (extent of the increase depends on PED of the good)