Bài giảng topic 8 market failure

Sources of Market Failure Produce the wrong amounts of goods or services due to externalities or ‘spillovers’  Failure to allocate sufficient resources to the production of certain go

Market Failure

Topic 8

What failure?

 In general, competition gives better results than a monopoly

 in terms of output, price & consumer surplus

give desirable results, and Government

intervention becomes necessary.

Sources of Market Failure

 Produce the wrong amounts of goods or services due to externalities or

‘spillovers’

 Failure to allocate sufficient resources to the production of certain goods, called ‘public’ or ‘social’ goods

 Information constraints

 Rent seeking & monopoly

 Non-market goals

Externalities (or spillovers)

 Definition: Costs or benefits associated with the

production or consumption of a good (or service) that flow on to 3 rd parties outside the market transaction

 External Costs

 e.g pollution from cars, smoke from factories etc

 External Benefits

 e.g development of new technology can also benefit the society

as well as the firm concerned

3 rd Party

External Costs or Diseconomies

 Over allocation of resources

 Qe equilibrium output

 Q0 socially optimal output

 Society’s loss = cbf

supply curve fails to include external costs, the

equilibrium price is artificially too low and the equilibrium quantity is artificially too high

(ie there is an overallocation

of resources)

Includes external costs

Excludes external costs

External Costs or Diseconomies

 Policy implications: Try to internalise (or capture) external costs

 Ban the products

 Impose additional duties and taxes

 Property rights (eg in the case of environmental pollution)

Q

D

0

External costs

S t S

TAX

Over-allocation corrected

Q0 Q e

Correcting for External Costs

External Benefits or Economies

 External benefit = gk

 Under allocation of resources

 Qe equilibrium output

 Q0 socially optimal output

 Society’s loss = gkh

 Policy implications:

 Government produces the goods

 Subsidize producers or buyers

 Property rights (patents etc.)

Includes external benefits

Excludes external benefits

Correcting for External Benefits

P

Q D S

0

D t

Subsidy

to consumer

Under-allocation

corrected

Q

D

0

Subsidy to producers increases supply

S t S′ t

Under-allocation

corrected

Q e Q0

Correcting for External Benefits

Characteristics of Private Goods

 Goods that are produced through the market system.

 Divisible : goods comes in units small enough to be bought by individual buyers.

 Excludable : people who are willing and able to pay the equilibrium price will consume the product, but the people who are unable or unwilling to pay are

excluded from the benefits provided by that particular product

Characteristics of Public Goods

market system.

“units” so that they can be sold to individual

buyers.

excluding individuals from the benefit available from the consumption of public goods once

these goods have been produced.

referred to as pure public goods

Public Goods vs Private Goods

Private goods

Produced through the

market system

 Divisible

 Excludable

Public goods

Not provided by the market system

 Indivisible/joint consumption possible

 Non-excludable

exclusion principle)

– free rider problem

Free - Rider Problem

benefits from the consumption of goods and services without contributing directly to its

costs.

 Given the inapplicability of the exclusion

principle (free-rider problem), there is no

economic incentive for private firms to supply

public goods.

 As a result, government has to step in to

provide the good (or service) because of its

substantial social benefits

Characteristics of Quasi (near)

public goods

 Joint consumption is possible up to a certain capacity

 Exclusion is possible

 Eg public transport (bus, train travel), museums, libraries, a football match, etc

goods can be privately produced In this case

“public” does not mean “Government owned

or made”.

Information Constraints

 Consumers may not have complete information (or understanding) about some products

 e.g medicines, houses, cars, TV sets etc

 If the consequences of having incomplete or

wrong information are severe, the Government may intervene

 Interventions could be in the form of warranties, production standards, product liability etc.

Rent seeking

 Rent seeking involves any unproductive

activity undertaken to earn supernormal profits e.g lobbying for quotas, market protection

from imports, changes in tax/duties, monopoly rights etc.

 There is a double loss: (a) resources wasted on rent seeking (b) loss because of misallocation

of resources (due to the quota, tariff etc)

 The Government needs to handle such

situations using specific policies

Non market Goals

maximisation to be the ultimate economic goal for a firm

 Some activities are not driven by profit (or

may not even generate any revenue)

 socially desirable

 e.g orphanages, animal shelters, free primary

education etc.

 Left to itself, the market will not produce such goods Thus Government intervention is

required.

Past Exam Question

 When the market fails to operate efficiently, the government may be required to intervene Outline the type of measures the government would be expected to take when the market failure was due to:

 (i) an external cost (or external diseconomy)

 (ii) the commodity involved being a public good.