Market Failure

1. Market Failure

2. Content • Externalities in Production and Consumption: • Positive • Negative • Public goods • Merit goods • Demerit goods • Market imperfections • Inequalities in: • Wealth distribution • Income distribution

3. Externalities • Externalities result from differences between private and social costs or benefits • Externalities can be positive or negative: • Positive – these have beneficial effects on 3rd parties • Negative – these are costs that incurred by 3rd parties

4. External Costs / Negative externalities • External costs created by businesses can impact the environment in the following ways: • Urban blight – excessive development and inappropriate developments mean the environment is visually less attractive, loss of farmland • Production and disposal of waste – this could include an increase in litter and rubbish from packaging • Use of energy • Pollution: • Noise – from cars, lorries, factories etc • Air – emissions from cars and delivery vehicles • Land • Sea • Water

5. Negative externalities • If you consider private costs then they would supply along supply curve S • Negative externalities mean that social costs are higher so the new supply curve should be S1 and equilibrium moved to P1

6. External Benefits / Positive externalities • As well as external costs businesses can create external benefits • External benefits are advantages a business brings to the local community when it locates its business in a particular area. These benefits will be positive for the local community. • Examples: • Employment • Quality of life • Providing a service • Regeneration of land

7. External Benefits / Positive Externalities • If the business was supplying products ignoring social benefits the initial supply curve S1

8. External Costs and benefits In production • External costs are where MSC = MSB – MPC e.g. pollution, traffic congestion • External benefits are where MSC < MPC e.g. research and development in industry, human resource development

9. External costs and benefits in consumption • External costs = where MSB < MPB e.g. anti-social behaviour, passive smoking, noise • External benefits = where MSB > MPB e.g. public transport, vaccinations, attractive surroundings

10. Externalities • The presence of negative externalities is likely to cause over production of a product • The presence of positive externalities is likely to lead to under production of a product • Externalities can lead to market failure if the pricing mechanism fails to account for the social costs and benefits of production

11. Value of Externalities • The value of social costs and benefits can be measured by looking at: • Consumer surplus • Producer surplus • Cost-benefit analysis : what is the balance of costs and benefits • Willingness to pay

12. Cost Benefit Analysis • Identify all costs and benefits • Measure the value of all costs and benefits • Calculate the likelihood of costs and benefits • Analyse the timing of the costs and benefits looking at present value • Decide whether the project is worth undertaking

13. Public Goods • These are services that are provided by the government • Pure public goods have the following characteristics: • Non excludability – everyone can consume the goods whether they pay or not • Non rivalry in consumption – consumption by one person doesn’t reduce consumption for others • Examples – street lighting, national defence

14. Public goods and Market Failure • You cant get an individual to pay for public goods as others can get the benefits from consumption without paying • Private companies will not supply public goods as they don’t make an economic profit on them • Public goods are only supplied by the government and financed through taxation

15. Private goods • Private goods have the following characteristics: • Excludability – if you don’t pay you can be excluded from consuming the product • Rivalry – the consumption of one person reduces the amount available for others to consume • Rejectability – you can choose not to consume them and therefore reject them

16. Merit goods • Merit goods are where social benefits exceed social costs – they generate positive externalities • Governments aim to provide more of these goods due to the benefits to society • They may subsidise the production of such goods reducing the marginal costs of consumption and therefore increasing demand • Examples – healthcare, education

17. Merit goods and Market Failure • If the government didn’t step in and produce merit goods then they would be under produced • Attributable to the fact that individuals do not realise the benefits of consuming these goods

18. Demerit goods • Demerit goods are where social costs outweigh social benefits – they generate negative externalities • Governments try and reduce the consumption of these goods through higher taxes • Examples – cigarettes, alcohol

19. Market imperfections • Monopolies – these are often viewed as allocating resources inefficiently as the producer is able to charge higher prices due to being the only producer in the market • Imperfect knowledge of the market can also cause market failure

20. Immobility of factors of production • These can lead to market failure and may be due to: • Occupational immobility – this occurs when there are barriers of mobility between different jobs and different industries • Geographical immobility exists when there are barriers to people of moving to different locations

21. Inequalities • In market economies an individuals ability to consume goods and services is dependent on their income / wealth • An uneven distribution of income / wealth within an economy can result in an unsatisfactory allocation of resources and therefore market failure • In many developing countries income inequality is great therefore resulting in misallocation of resources

22. Summary • Externalities are caused when social benefits / costs are different to private benefits / costs • Positive externalities occur where social benefits are greater than private benefits • Negative externalities occur where social costs are greater than private costs • Cost benefit analysis looks at the costs and benefits of producing / consuming a product • Public goods are goods that are provided by the government e.g. street lighting • Merit goods are where social benefits exceed social costs e.g. healthcare the government encourages people to use these • Demerit goods are where social costs exceed social benefits e.g. smoking the government discourages people to use these through taxation • Market imperfections can be caused by monopolies, imperfect market knowledge and factor immobility which can result in misallocation of resources • Inequalities in wealth and income distribution may result in a misallocation of resources as the rich consume more