AS – Market Failure Rising Food & Fuel Prices

1. AS – Market FailureRising Food & Fuel Prices

2. What is market failure? • Definition: The failure of the market mechanism to allocate scare resources in an efficient manner. i.e. The free market/ price mechanism is not working properly.

3. What is the market failure being raised? • Information Failure • Income Distribution • Market Imperfections • Monopoly Power – possibly in the provision of fuel

4. Fuel Prices rising - solutions • Insulation • Why do people not buy this themselves? • Perhaps it is an information failure – people left to their own devices do not see the positive externalities to be gained from insulation • Government provision of cheaper insulation to reduce the demand for heating fuel.

5. Internalising the positive externality

6. Evaluation • Cost involved – is there an opportunity cost? • Who pays for the insulation? Government through raised taxation or windfall tax? • Impact of windfall tax on energy company profits and innovation • Moral Hazard – people become too reliant on the state. • Long-term solution – takes time to enact.

7. Windfall Tax • Redistribution of profits from the energy companies to the consumers – in particular pensioners through winter fuel payments

8. Windfall tax • Points to consider • What will it do to future investment in energy companies? • Will energy companies pass on any higher tax to consumers in the form of higher prices? • Will it mean a need to cut costs and therefore jobs? • Will it reduce budgets for innovation and product improvement and customer service?

9. Rising food prices • US intervention – subsidising ethanol production has caused corn/maize prices to rise.

10. Solutions to rising prices • Increase output • How? • Green revolution • Innovation, research and development, genetically modified foods – paid for by government subsidies. • Education – reduction of waste

11. Wider impact of rising food prices • Developed world • Increased cost of importing food – • Inflation • Balance of payments deficits on the current account increasing • Developing world • Those that export food maybe better off – but may have to spend any income on imports of other raw materials • Those that import food will need to pay more for food, causing inflation and increased pressure on subsidies for food to keep prices affordable

12. When evaluating a question – ask yourself • How long does it take? – SR impact v LR impact e.g. Speed with which a subsidy will work. • How Significant? – in other words how big has the change been? Is it a £100 m or £1 b subsidy • How likely? - How likely is the change to occur?e.g. Is the government likely to impose an unpopular windfall tax? • What is the Magnitude – How large an impact will the changes described have?