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Market Failures and Government Policy

Explore market failures including externalities, public goods, and monopoly power. Learn about social efficiency, equity, and deadweight loss under monopoly. Understand how government policies can address these failures.

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Market Failures and Government Policy

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  1. Market Failures and Government Policy

  2. Market Failures: Externalities and Public Goods • Society's microeconomic objectives • equity • social efficiency • marginal social benefits and costs • production where MSB = MSC

  3. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC

  4. External costs in production MC = S P D Q1 Costs and benefits O Quantity

  5. External costs in production External cost Q2 Social optimum MSC MC = S Costs and benefits P D O Q1 Quantity

  6. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC

  7. External benefits in production MC = S Costs and benefits P D O Q1 Quantity

  8. External benefits in production External benefit Q2 Q1 Social optimum MC = S MSC Costs and benefits P D O Quantity

  9. External benefit External cost External costs and benefits in production MSC MC = S MSC MC = S Costs and benefits (£) Costs and benefits (£) D P P D O O Q Q Q Q 2 1 2 1 Quantity Quantity (b) External benefits (a ) External costs

  10. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC • External costs of consumption

  11. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC • External costs of consumption • MSB < MB

  12. External costs in consumption (MB) MU = D Q1 Costs and benefits P D O Quantity

  13. External costs in consumption External cost (MB) MU = D Q2 Social optimum Costs and benefits P D MSB O Q1 Quantity

  14. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC • External costs of consumption • MSB < MB • External benefits of consumption

  15. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC • External costs of consumption • MSB < MB • External benefits of consumption • MSB > MB

  16. External benefits in consumption (MB) MU = D Costs and benefits P D O Q1 Quantity

  17. External benefits in consumption External benefit (MB) MU = D Q2 Social optimum Costs and benefits P D MSB O Q1 Quantity

  18. External benefit External cost Q Q Q Q 2 2 1 1 External costs and benefits in consumption Costs and benefits (£) Costs and benefits (£) P P P P MSB MB MB MSB O O Rail miles Car miles (b) External benefits (a ) External costs

  19. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC • External costs of consumption • MSB < MB • External benefits of consumption • MSB > MB • Public goods

  20. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC • External costs of consumption • MSB < MB • External benefits of consumption • MSB > MB • Public goods • non rivalry

  21. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC • External costs of consumption • MSB < MB • External benefits of consumption • MSB > MB • Public goods • non rivalry • non-excludability

  22. Market Failures: Monopoly Power • The demand curve under monopoly • production at less than the social optimum

  23. A monopolist producing less than the social optimum MC P1 MC1 AR MR Q1 Monopoly output £ O Q

  24. A monopolist producing less than the social optimum Perfectly competitive output Monopoly output £ MC = MSC P1 P2= MSB = MSC MC1 AR = MSB MR O Q Q2 Q1

  25. Market Failures: Monopoly Power • The demand curve under monopoly • production at less than the social optimum • Deadweight loss under monopoly • consumer and producer surplus • consumer surplus

  26. Market Failures: Monopoly Power • The demand curve under monopoly • production at less than the social optimum • Deadweight loss under monopoly • consumer and producer surplus • consumer surplus • producer surplus

  27. Market Failures: Monopoly Power • The demand curve under monopoly • production at less than the social optimum • Deadweight loss under monopoly • consumer and producer surplus • consumer surplus • producer surplus • total surplus

  28. Deadweight loss under monopoly a Ppc Qpc MC (= S under perfect competition) £ Consumer surplus Producer surplus AR = D O Q (a) Industry equilibrium under perfect competition

  29. Market Failures: Monopoly Power • The demand curve under monopoly • production at less than the social optimum • Deadweight loss under monopoly • consumer and producer surplus • consumer surplus • producer surplus • total surplus • the effect of monopoly on total surplus

  30. Deadweight loss under monopoly Deadweight welfare loss b Pm MR Qpc MC (= S under perfect competition) £ Consumer surplus a Ppc Producer surplus AR = D O Qpc Q (b) Industry equilibrium under monopoly

  31. Deadweight loss under monopoly Perfect competition a Ppc Qpc MC (= S under perfect competition) £ Consumer surplus Producer surplus AR = D O Q (a) Industry equilibrium under perfect competition

  32. Deadweight loss under monopoly Monopoly Deadweight welfare loss b Pm MR Qpc MC (= S under perfect competition) £ Consumer surplus a Ppc Producer surplus AR = D O Qpc Q (b) Industry equilibrium under monopoly

  33. Market Failures: Monopoly Power • The demand curve under monopoly • production at less than the social optimum • Deadweight loss under monopoly • consumer and producer surplus • consumer surplus • producer surplus • total surplus • the effect of monopoly on total surplus • Other problems with monopoly

  34. Market Failures: Monopoly Power • The demand curve under monopoly • production at less than the social optimum • Deadweight loss under monopoly • consumer and producer surplus • consumer surplus • producer surplus • total surplus • the effect of monopoly on total surplus • Other problems with monopoly • Possible advantages from monopoly

  35. Other Market Failures • Ignorance and uncertainty • Immobility of factors and time lags • Protecting people's interests • dependants • the principal–agent problem • the problem of asymmetric information • the need for monitoring • poor economic decision making by people • merit goods • Macroeconomic goals • Economists and policy advice

  36. Government Intervention: Taxes and Subsidies • The use of taxes and subsidies to correct externalities • the optimum size of a tax

  37. Using taxes to correct a market distortion MC = S P D Q1 Costs and benefits O Quantity

  38. Using taxes to correct a market distortion External cost Q2 Social optimum MSC MC = S Costs and benefits P D O Q1 Quantity

  39. Using taxes to correct a market distortion Optimum tax = MSC–MC MC Q2 MSC MC = S Costs and benefits P D O Q1 Quantity

  40. Government Intervention: Taxes and Subsidies • The use of taxes and subsidies to correct externalities • the optimum size of a tax • the optimum size of a subsidy

  41. Using subsidies to correct a market distortion MC = S Costs and benefits P D O Q1 Quantity

  42. Using subsidies to correct a market distortion External benefit Q2 Q1 Social optimum MC = S MSC Costs and benefits P D O Quantity

  43. Using subsidies to correct a market distortion MC Optimum subsidy = MC – MSC MC = S MSC Costs and benefits P D O Q2 Q1 Quantity

  44. Government Intervention: Taxes and Subsidies • The use of taxes and subsidies to correct for monopoly • use of lump-sum taxes • Advantages of taxes and subsidies • Disadvantages of taxes and subsidies • infeasible to use different tax and subsidy rates • lack of knowledge

  45. Government Intervention: Laws and Regulation • The use of laws and regulation • Advantages of legal restrictions • simple to understand • safer when size of problem is potentially great • quick to implement • a good way of dealing with imperfect information • Disadvantages of legal restrictions • a 'blunt weapon'

  46. Government Intervention: Laws and Regulation • Types of regulation • The system of regulation in the UK • UK regulatory bodies • price-cap regulation • the RPI–X formula • Advantages of the UK system • discretionary • flexible • incentive for firms to reduce costs • Disadvantages of the UK system

  47. Other Forms of Government Intervention • Changes in property rights • the problem of limited property rights • extending property rights • limitations of this solution • impractical in many situations • problems of litigation • questions of equity • Provision of information • consumer information • information on jobs • information to firms

  48. Other Forms of Government Intervention • Direct provision of goods and services • the provision of public goods • the need to evaluate costs and benefits of publicly provided goods • the provision of other goods and services by the government • social justice • large positive externalities • dependants • ignorance

  49. More or Less Intervention? • Drawbacks of government intervention • shortages and surpluses • poor information • bureaucracy and inefficiency • lack of market incentives • shifts in government policy • lack of freedom for the individual

  50. More or Less Intervention? • Advantages of the free market • automatic adjustments • dynamic advantages of capitalism • possibly high degree of competition even under monopoly/oligopoly • Judging the arguments • Should there be more or less intervention in the market? • important to consider both costs and benefits of intervention • moral issues • problem of predicting effects of intervention

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