Transcript MC - Gore High School

Demonstrate
Understanding of
Government
Interventions to
Correct Market Failures
Market Failure

Market failure occurs when the market does
not result in efficient or equitable outcomes.
Efficiency

Efficiency occurs when Social Marginal Cost
equals Social Marginal Benefit.

in this Achievement Standard efficiency is about social
allocative efficiency rather than the market allocative
efficiency studied in other Achievement Standards.

The conditions for the market system to work perfectly are
not met so the price/market system will not achieve ‘social’
allocative efficiency.
Equity
Equity occurs if a situation or outcome is
considered to be fair.
 Fairness is a matter of opinion often based on
peoples values
e.g. some person/group will think its fair to
tax high income earners more than low
income earners while other people/groups
may consider this unfair.

Government Intervention
Market failure is a justification for
Government intervention into the market
system to ‘right the wrongs’
Examples of Market Failure






consumers do not always act in their best interests e.g. over
consuming alcohol, smoking cigarettes.
producers do not always act in society’s best interests e.g.
over polluting, producing unsafe goods
the market may fail to provide the right quantity of certain
goods and services e.g. adequate housing and healthcare,
public parks.
the market does not ensure everyone earns reasonable
income e.g. how do the unemployed income.
the market will not ensure that everybody receives an
education
What are the Different Market Failures?
The different market failures to study are
 consumption externalities
 production externalities
 public goods
 imperfect information
 inequitable income distribution
What are the Different Government
Interventions / Policies?
The Government can intervene in markets in a number
of ways e.g.
 Subsidies
 Taxes
 Regulations
 Establish property rights
 Government provision
 Welfare benefits
Externalities
Externalities are unintended side effects that
result from production or consumption
 They affect others not directly involved
 Externalities can be positive or negative

e.g.
 [1] pollution from a factory means a car sales yard has to
continually clean its cars. [negative externality]
 [2] more people using public transport reduces congestion in
the central city for others vehicle users [positive externality]
Social Cost and Benefits

Social Cost - Cost to society due to a
negative externality.
[also called Spillover Cost]

Social Benefit - benefit to society due
to a positive externality.
[also called Spillover Benefit]
Externality Model
MB, MC,
SMC,
SMB
$
MC = SMC
Pp
MB = SMB
0
Qp
Quantity
MC = Marginal Cost
[= supply curve]
SMC = Social Marginal
Cost
MB = Marginal Benefit
[= demand curve]
SMB = Social Marginal
Benefit
Pp = private market price
Qp = private market
quantity
What is MC, SMC?
Marginal Costs [MC] – the firms’ extra cost of
producing an extra good unit.
 Social Marginal Cost [SMC] – represents the
firms marginal cost PLUS the spillover/social
costs [or benefits] to society from producing
that good.

What is MB, SMB?
Marginal Benefit [MB] - extra benefit gained by
the consumer from the consumption of extra
units of a good.
 Social Marginal Benefit [SMB]– represents the
consumers marginal benefit PLUS the spillover
benefits [or costs] to society of consuming the
good.

Negative Externalities of Production



Cost to society of producing the good is higher than
the cost to individual firms
e.g. pollution.
producing this good results in spillover costs to
society.
In this case SMC > MC
[the Social Marginal Cost is greater than the Marginal
Cost]
Negative Externalities of Production - Model
MB, MC,
SMC,
SMB
$
SMC
MC
Ps
Pp
MB = SMB
0
Qs Qp
Quantity
SMC = SMB is the
socially desirable
equilibrium and is
allocatively efficient
from society viewpoint
Therefore from society’s
viewpoint
 Price should be Ps [the
social price]
 Quantity should be Qs
[the social quantity]






Without any Government intervention the market will
continue to produce at Pp and Qp [where SMB = MC]
Therefore the unregulated market will NOT be socially
allocatively efficient as SMB ≠ SMC
The market fails as the good is over-produced and underpriced [from society’s viewpoint too much is produced and
the price is too low.]
MB, MC,
SMC
The social cost will
be as shown [blue shaded
area including dotted
area]
SMC,
SMB
$
The social deadweight loss
equals the dotted area
MC
Ps
Pp
MB = SMB
0
Qs Qp
Quantity
Government Interventions for
Negative Externalities of Production
Possible Government Interventions are:
 Taxation – tax the sale of the good. This will raise price and
reduce consumption to Qs
 Regulation – limit the sale or production of the good so only Qs
is produced
 Education – Government funded education campaigns that
inform people about the social costs . This will reduce MB
[demand] and therefore consumption/ production falls to Qs
 Property Rights – establish property rights so the firm causing
the social/spillover costs has to pay the groups affected by the
spillover costs or pay for methods to reduce the negative
externality. This would raise firm’s costs of production and

they will respond by reducing production back towards Qs
Example of a Government Intervention to
Correct a Market Failure using a Model

Negative Externality of Production
e.g. A large industrial factory called Onceler Ltd makes
Thneeds. It is discharging large amounts of pollution into the
atmosphere.

Government Intervention
To impose a sales tax on Thneeds
Government Intervention - Model
A sales tax will shift MC to where the SMC curve is.
 This will raise the price of
Thneeds to PTax [= Ps] the
MB, MC,
SMC = MCTax
SMC,
socially desirable price
SMB
MC
 This will reduce the quantity
$
of Thneeds produced to Qtax
[ = Qs] the socially desirable
PTax= Ps
quantity.
Pp
 Now MCTax = SMC = SMB at
the socially desirable
equilibrium and the market is
allocatively efficient from
MB = SMB
society’s viewpoint.
 The social deadweight loss is
Quantity
0
Qs Qp
eliminated and social cost is
= QTax
reduced [blue shaded area]

Positive Externalities of Production



Cost to society of producing the good is lower than
cost to individual firms
e.g. bees pollinating a apple orchard so more apples
are produced.
Producing this good results in spill-over benefits to
society.
In this case SMC < MC
[the Social Marginal Cost is less than the Marginal
Cost]
Positive Externalities of Production Model
SMC = SMB is the
socially desirable
equilibrium and is
allocatively efficient
from society viewpoint
Society benefits from the
production of this good
therefore from society’s
viewpoint
 Price should be Ps [the
social price]
 Quantity should be Qs
[the social quantity]

MB, MC,
SMC,
SMB
$
MC
SMC
Pp
Ps
MB = SMB
0
Qp
Qs
Quantity





Without any Government intervention the market will
continue to produce at Pp and Qp [where SMB = MC]
Therefore the unregulated market is NOT socially allocatively
efficient as SMB ≠ SMC
The market fails as the good is under-produced and overpriced [from society’s viewpoint too little is produced and the
price is too high]
MC
MB, MC,
The social benefit
is the blue shaded
area
SMC,
SMB
$
SMC
Pp
Ps
The social deadweight
loss equals the dotted
area
MB = SMB
0
Qp Qs
Quantity
Workbooks Page 163-164
Government Interventions for
Positive Externalities of Production
Possible Government Interventions are:
 Susidise – subsidise the production of the good. This will raise
production to Qs and encourage consumption by lowering price
 Regulation – make production/consumption compulsory, this
will increase production to Qs
 Education – Government funded education campaigns that
inform people about the social benefits . This will increase MB
[demand] and therefore consumption/ production rises to Qs
 Property Rights – establish property rights so the firm causing
the social/spillover benefits has the right to benefit from the
positive externality. This would reduce firm’s costs of
production and/or encourage production so prodcution
increases towards Qs.
165 – 166
Positive Externalities of Consumption

One person’s consumption benefits others. i.e. the
benefit to society is greater than the benefit to the
individual.
e.g. using public transport rather than a private vehicle to
travel into the city to work has spillover benefits to others as
there is less congestion on the roads, noise pollution is less,
more parking available etc.

producing this good results in spillover benefits to
society.

In this case SMB > MB
[the Social Marginal Benefit is greater than the
Marginal Benefit]
Positive Externalities of Consumption - Model
MC = SMC
Pp
Ps
SMB
MB
0
SMC = SMB is the
socially desirable
equilibrium and is
allocatively efficient
from society’s viewpoint
Therefore from society’s
viewpoint
 Quantity should be Qs
[the social quantity]
 Price should be Ps [the
social price] Note: Ps is not

MB, MC,
SMC,
SMB
$
Qp
Qs
Quantity
at intersection of SMB and
MC





Without any Government intervention the market will
continue to produce at Pp and Qp [where SMC = MB]
Therefore the unregulated market will NOT be socially
allocatively efficient as SMB ≠ SMC
The market fails as the good is under-produced and overpriced [from society’s viewpoint too little is produced and the
price is too high].
The social benefit is the
blue shaded area
MB, MC,
SMC,
SMB
$
The social deadweight loss
equals the dotted area
MC = SMC
Pp
SMB
Ps
MB
0
Qp
Qs
Quantity
Workbooks page 153 - 154
Government Interventions for
Positive Externalities of Consumption
Possible Government Interventions are:
 Susidise – subsidise the production of the good. This will raise
production to Qs and encourage consumption by lowering price
 Regulation – make production/consumption compulsory, this
will increase production to Qs
 Education – Government funded education campaigns that
inform people about the social benefits . This will increase MB
[demand] and therefore consumption/ production rises to Qs
 Property Rights – establish property rights so the firm causing
the social/spillover benefits has the right to benefit from the
positive externality. This would reduce firm’s costs of
production and/or encourage production so prodcution
increases towards Qs.
Workbooks page 155 -156
Negative Externalities of Consumption

One person’s consumption has a cost to others i.e. the
cost to society is greater than the cost to the
individual.
e.g. over-consumption of alcohol.

consuming this good results in spillover costs to
society.

In this case SMB < MB
[the Social Marginal Benefit is less than the
Marginal Benefit]
Negative Externalities of Consumption - Model
MC = SMC
Ps
Pp
MB
SMB
0
SMC = SMB is the
socially desirable
equilibrium and is
allocatively efficient
from society’s viewpoint
Therefore from society’s
viewpoint
 Quantity should be Qs
[the social quantity]
 Price should be Ps [the
social price] Note: Ps is not

MB, MC,
SMC,
SMB
$
Qs
Qp
Quantity
at intersection of SMB and
MC





Without any Government intervention the market will
continue to produce at Pp and Qp [where SMC = MB]
Therefore the unregulated market will NOT be socially
allocatively efficient as SMB ≠ SMC
The market fails as the good is over-produced and underpriced [from society’s viewpoint too much is produced and
the price is too low].
The social cost will
be as shown [blue shaded
area including dotted
area]
MB, MC,
SMC,
SMB
$
MC = SMC
Ps
Pp
The social deadweight loss
equals the dotted area
MB
SMB
0
Qs
Qp
Quantity
Government Interventions for
Negative Externalities of Consumption
Possible Government Interventions are:
 Taxation – tax the sale of the good. This will raise price and
reduce consumption to Qs
 Regulation – limit the sale or production of the good so only Qs
is produced
 Education – Government funded education campaigns that
inform people about the social costs . This will reduce MB
[demand] and therefore consumption/ production falls to Qs
 Property Rights – establish property rights so the firm causing
the social/spillover costs has to pay the groups affected by the
spillover costs or pay for methods to reduce the negative
externality. This would raise firm’s costs of production and

they will respond by reducing production back towards Qs
MC’
Cost
Benefit
MC
Ps
-The govt imposes a indirect
tax equal to the size of the
spillover cost
Price
Pp
$
The social cost can be
internalised if
Tax level
MB
MSB
Qs
Spill over cost
Dead Weight Loss
Qp
-This causes a shift of the
supply curve to the left as
producers cost of production
increases
-The new equilibrium
(MC’=MB) is at a increased
price level and decreased
Q level of output produced and
consumed
- New equilibrium output =
QS thus increasing efficiency
in the market.
Workbooks page 160 – 161
PUBLIC GOODS

Public goods are goods which are non-rival/non-depletable
and non-excludable by price.

Non-rival/non-depletable means that if one person uses the
good it does not prevent other people from using the good.
e.g. street lighting – if one person uses it, other people can
still use it.

Non-excludable means goods can not be withheld from those
who do not pay e.g. street lights are available for those who
do not pay rates.
Examples of Public Goods

Roads, footpaths, street lights, public parks

Public goods by their nature result in positive externalities of
consumption.
Society benefits from the provision of public goods

Because public goods are non excludable
property rights over public goods may be
difficult to establish
Private Goods
Characteristics are :
 Consumption is rival/depletable i.e. if one person has the
good then it is not available to others
 Consumption is excludable by price i.e. if the price is not paid
the benefits are not enjoyed.
 There are no externalities
 Property rights [ownership] is clear.
Government Provision of Public Goods

Because public goods are non excludable and non rival it is
impossible to charge a price for them. Therefore private firms
will not provide public goods as no profit can be made.

Because the market fails to provide public goods the
Government has to intervene and provide public goods
[through use of taxation]

This ensures society enjoys the benefits of public goods.
Free Rider Behaviour

The refusal to contribute to the cost of a public good on the
basis that once it is provided, it is impossible to prevent
people from using.

Free riders are consumers who enjoy the benefits of a good
without making any payment. This occurs because public
goods are non-excludable.
e.g. overseas tourists using public parks
Economic Model for Public Goods

The Marginal cost for the next user is zero, so for allocative
efficiency to occur the price must be zero
Costs,
Benefits
$
 Social allocative efficiency
occurs where SMB = MC
 At Qs the maximum social
benefit is gained form the public
good
 The social benefit gained is the
area [triangle] to the left of SMB
SMB
Qs
MC = 0
Quantity
Charging a Price for Public Goods


If a price is charged then only Q1 will be consumed
There is a loss of social allocative efficiency as social benefit is
not being maximised [green triangle]
Costs,
Benefits
$
Loss in
social
benefit
P1
SMB
Q1
Qs
MC = 0
Quantity
Users Pays

Principle that those who use public goods or
collective goods should have to pay.

However charging for public goods will result in less
consumption/use of public goods and less social
benefit is gained.
Collective Goods

are goods that the government provides free of direct charge
and which are paid for by taxation
Mixed Goods

a good that have characteristics of both private and public
goods.
Inequitable Income Distribution

The free market does not ensure that income distribution is
equitable. [= market failure]

In the free market some people earn more than enough
income to live on, while others do not earn enough.

Equity of income means that people’s incomes are fair.
[equitable = fair, inequitable = unfair]

Equality of income means that people’s incomes are the
same.
Can Incomes be Equal?

Equality of income is not a goal of society as it is recognised
that if someone works harder/longer/has more skills,
responsibilities etc. then this should be rewarded with more
income.

However, the Government will attempt to make income
distribution fairer [in their opinion] by ensuring the lower
paid have enough income to live reasonably.
The Lorenz Curve

Lorenz Curves are used to show inequality of income or
wealth. The red line is the Lorenz Curve and it shows that
income distribution is not equal.
of income
Lorenz Curves [continued]




Lorenz curves show how far away distribution of income in a
society is from complete equality.
The line of complete equality (45 line) shows all households
earning the same income.
The closer the Lorenz curve to the 45 line, then the more
equal incomes are.
The Lorenz Curve above [red line] shows income inequality as
50% of income earners earn only 20% of the total income
earned or that the top 10% of income earners earn 30% of
the income
Government Intervention
There are a number of ways the Government intervenes to
make incomes distribution fairer.
 Progressive income tax - people on higher salaries/wages pay
a greater proportion of their income in taxation than those on
lower salaries/wages.

Transfer payments such as benefits are paid to the
unemployed, the long-term sick etc.

Collective goods may be provided to those on lower income
e.g. subsidised housing
Government Intervention [cont]

Targeted subsidies may be provided to those on lower
incomes e.g. community service cards for health services.

Legislation is enacted e.g. minimum wage of $13.75 per hour
for employees aged 16 and older.

Equality of opportunity is promoted e.g. free education and
health care to the young.
Effect of Government Intervention on the
Lorenz Curve

Progressive taxes and paying benefits to low income earners
will make income distribution more equal [the Lorenz curve
moves inwards]
of income
Equity Issues



Government Interventions aimed to make income distribution
more equal [e.g. progressive tax rates] can be
[a] Fair or equitable – because people on lower incomes need
extra income [after tax] to help them afford the basic
necessities of life whereas higher income earners can afford
to pay higher tax. Therefore it is fair lower income earners
pay lower rates of tax on their income OR
[b] Unfair or inequitable – because high income earners may
deserve their higher income through working longer hours,
being better qualified, responsibility etc. so why should they
pay a higher tax than someone else.
Equity - Efficiency Trade-off


Government interventions aimed to make income distribution
more equal lead to equity gains but they also lead to
efficiency losses
e.g. more progressive tax rates will make income distribution
more equal [equity gain] but also creates a disincentive to
work for people on higher
incomes [efficiency loss].
Efficiency
Equity
Imperfect Information

Perfect information means that anything that
may impact a buyer or seller's decision making
process is known and understood.

Imperfect Information occurs when people
have inaccurate, incomplete, uncertain or
misunderstood data.
Imperfect Information and Market Failure

Market failure exists when some, or all, of the
participants in an economic exchange do not have
perfect knowledge and so make potentially ‘wrong’
choices.

Market failure also exists when one participant in an
economic exchange knows more than the other,
[unbalanced, information] and this gives the
participant with better information a competitive
advantage
Examples of Imperfect Information

e.g. persuasive advertising may ‘oversell’ the benefits of a
product leading to more consumption than is optimal.

Spam mail may cause misinformation for consumers.

2nd hand car dealer trying to sell a car they know is poor
quality

Consumers being unaware of some of the side effects of
medication
Government Interventions for Imperfect
Information
The government has a role in trying to ensure that some of these
market failures are reduced or eliminated.
Some interventions include:
 producers are required by law to provide accurate
information about products through accurate labelling e.g.
alcoholic content of drinks is printed on alcoholic drinks

Government funded or subsidised education campaigns to
improve knowledge such as informing smokers and drinkers
of the true cost of their habit.
Government Interventions [continued]

Government may also regulate advertising standards to make
advertising more informative, and less persuasive. E.g Fair
Trading Act forbids misleading and deceptive advertising

Consumer Guarantees Act protects consumers by ensuring
that all goods and services provided by producers are of
acceptable quality otherwise they need to be repaired,
refunded, replaced.