Download 1Market Failure

1
Market Failure
MARKET FAILURE (3.4)
11
110
MARKET FAILURE (3.4)
Mind-maps are very good revision tools. Our minds learn by
making patterns. Mind-maps help you to make these patterns
and so makes the content easier to learn and remember.
BEFORE you start this unit (in pencil) ...
•write the key idea of this unit in the centre of the page
•write what you know about this idea around it and draw lines to them.
•try and group the ideas together
mind-map
1
12
AFTER you finish this unit (in pencil) ...
•remove anything that doesn’t belong to this unit
•ensure that things are grouped together appropriately. Move stuff around if needed
•add any extra ideas that you think are missing
MARKET
MARKET FAILURE
FAILURE (3.3)
(3.4)
unit over
view
?
s
t
c
e
f
f
e
e
id
s
e
h
t
fidid we mention
In achievement standard 3.2 we looked at two types of markets - perfect competition
and monopoly. These are the two extreme examples of perfectly competitive and
imperfectly competitive markets.
In this unit we look at the other types of markets, and how consumers and producers
behave in these markets.
by the end of this unit, you should be able to answer these questions...
1
what is market failure?
market failure
2
how can the
government respond to
market failure?
3
what are equity and
efficiency?
13
13
1
1
14
MARKET FAILURE (3.4)
The Free Market Model . . . Fact or Fiction?
1. The diagram below represents the idea of free markets providing a ‘level playing field’. Identify the conditions
necessary for markets to achieve allocative efficiency and then complete the text below.
Allocative
Efficiency
_______
_________
_ _ _ _ _P _ _ _
Free Market . . . Fact or Fiction?
__
___________
_ _ _ _ _ _ S_ _ _ _ _
_____________
D
Q
__
______
_____
_________
2. Use the words listed in the box below to complete the text that follows.
outcomes
inequity
allocative efficiency
externalities
solution
intervention
economic problem
The Free Market Model
We study one ______________ to the ______________ ______________ – the free market solution. This is the
Exercise 1.1
typical way most economies in the world try to achieve ______________ ______________. But not entirely.
Most also have some form of government ______________. This is usually necessary because the market does
not work properly and the Government has to fix it or because the market outcomes are considered socially
undesirable, i.e. ______________ or ______________ exist.
MARKET FAILURE (3.4)
15
Every three years the different political parties vie to be part of the New Zealand Government. To
get there, they must propose various social and economic policies that they believe New Zealand needs or the
public want.
110
1. Below are a list of suggested policies of various parties. Identify which economic role each policy relates to.
Policy
Economic Role
Labour has restored balance to workplace relations with a series of
legislative measures including the Employment Relations Act 2000 and
the Holidays Act 2003.
Public-Private Partnerships . . . the public and private sector should jointly
plan for required capacity in both facilities and workforce. Some new
hospital infrastructure and investment in new technologies, such as PET
scanners, can be financed by public-private partnerships.
. . . the next National Government will contribute an investment of up to
$1.5 billion in Crown capital over six years to accelerate the roll-out of
a fibre-to-the-home (broadband) network for New Zealand.
Tourism is a major contributor to the New Zealand economy and
Labour in government will continue to work in partnership towards a
secure and sustainable long-term future for the industry.
The Green Party will end child poverty:
• Work for a cross-party accord to end child poverty by 2010.
• Introduce a Universal Child Benefit and end Working for Families’
discrimination against beneficiary families.
• Raise the minimum wage to $12 an hour.
2. For each of the economic roles, find and describe a relevant policy proposed by a political party not referred to in (1.).
Economic Role
Allocative
Distributive
Regulatory
Policy
Government Intervention
Labour has refocused the immigration programme to facilitate the entry
of those migrants who are best placed to contribute to the New Zealand
economy.
Exercise 1.2
Stabilisation
MARKET FAILURE (3.4)
Introducing Market Failure
notes
Back to the Beginning ... The Price Mechanism
Society wants firms to produce the goods and services that people want. As preferences change,
e.g. growing demand for e-books over print books, we want firms to be aware of this and respond
to the changes in demand.
In Achievement Standard 3.3, we looked at how the price mechanism, i.e. market forces works to
get firms to allocate their resources away from goods or services less in demand (e.g. print books) to
producing goods and services more indemand (e.g. e-books).
Figure 1.1 shows this shift from print books to e-books on a production possibility curve. In this way
the price mechanism achieves allocative efficiency ... in and between markets.
Figure 1.1 ... The Price Mechanism and Allocative Efficiency Across Markets
print books
1
16
As consumer preferences shift towards e-books, the price
mechanism (market forces) will send signals to producers
that e-books are more profitable.
A
Firms will respond by producing more e-books and less print
books ... and so achieve allocative efficiency in each of the
markets and across the economy..
B
e-books
In the ideal world of market economists, market forces will operate smoothly and firms will always
use resources to produce exactly what consumers want ... and change this whenever consumers’
preferences change.
BUT THE WORLD’S NOT PERFECT
Price Mechanism: The way a simple piece of data, i.e. price, is able to convey a range
of complex information to buyers and sellers, and affect their behaviour.
MARKET FAILURE (3.4)
Market Failure
In reality, the price mechanism is not perfect. For a variety of reasons, market forces are not able to
operate as effectively as possible and so allocative efficiency does not occur.
This standard looks at four ways that the price mechanism (market forces) are unable to operate
correctly and so fail to achieve allocative efficiency:
• externalities: • public goods
the market fails to account for the side-effects of producers’ or consumers’ actions and so fails to produce the correct
quantity of a good or service.
the nature of a good or service means that there is no incentive
incentive for firms to produce it, even though people want it.
• market abuse / dominance
market conditions occur, or some in the market acts in a way, that one or a few firms manipulate a market to their advantage, at the expense of other consumers or producers
• inequality
an unequal distribution of income leads to long-term inequity where individuals, families or groups have less opportunity to participate in markets and wider society
Market failure does not mean that a market fails to achieve equilibrium.
A market may achieve equilibrium that but society as a whole may not be happy with the outcome.
An example of this is illegal drugs such as methamphetamines.
With no regulations firms, i.e. drug dealers, would produce
methamphetamines for customers. Supply and demand would
interact until they are equal, and producer and consumer
surpluses are maximised.
But ... methamphetamines are highly dangerous to the users
and those around them. If we allowed the market to produce
them because there’s demand for them, we would have more
crime. And society doesn’t want that.
So from society’s point of view producing any
methamphetamines is producing more than society wants
as a whole due to the unwanted side-effects. Even though
the price mechanism is working in a pure theoretical sense,
it is not producing the outcome society wants and so it not
allocatively efficient.
So market failure can be when conditions prevent a market from operating efficiently ... OR ... when
a market does operate efficiently, but the wider society is not happy with the outcomes.
In either of these cases, the government needs to step in to address the market failure.
Market Failure:
When the price mechanism is not able to operate and markets
are unable to achieve allocative efficiency..
17
1
1
18
MARKET FAILURE (3.4)
Figure 1.2 ... Conditions of Market Failure
MARKET FAILURE
OCCURS WHEN . . .
CONDITION
POSSIBLE RESPONSE
Consumer Sovereignty
. . . consumers choose what to buy
. . . the government chooses to restrict
consumers’ choices, e.g. heroin, fire
crackers, guns
. . . government regulation
. . . all four assumptions are true:
. . . one of the assumptions is broken
. . . anti-monopoly legislation
many buyers and sellers
perfect knowledge
identical product
. . . consumer laws
e.g. Fair Trading Act,
Consumer Guarantees Act
no barriers to exit and entry
. . . consumers have the final say in
what is produced
Perfect Competition
e.g. barriers to entry exist
one firm dominates the market
and produces a level of output
below market equilibrium and
allocative fficiency.
e.g. imperfect knowledge
misleading advertising results in
consumers making incorrect
decisions.
No Externalities
. . . no unintended (and unpaid for)
side-effects occur when people
make or consume goods and
services
. . . factories produce smog, but don’t
pay for it
. . . regulation of production or
consumption
. . . consumers create pollution (e.g.
2nd-hand smoke) that others
suffer
. . . subsidies or sales taxes
. . . unable to stop people accessing a
good or service for free, firms will
choose not to produce them, e.g.
national parks, national defence,
roading
. . . government provision of these
goods / services.
. . . identify property rights
No Public Goods
. . . firms can restrict access to their
goods or services and so charge
consumers for them
Government Intervention to Resolve Market Failure
The New Zealand economy is predominantly a
market economy, i.e. the majority of goods and
services are produced by private firms for individual
consumers in markets through New Zealand.
But for the reasons identified above, the markets
often fail. Either they are unable to operate
efficiently, or they produce outcomes that society as
a whole is not happy with - such as the example of
methamphetamines.
Where market failure occurs, the government
usually steps in to address the failure. Government
interventions in the economy fall into four roles:
• allocative
provision of goods and service (e.g. health, education)
• distributive
the transfer of wealth or income between different groups in society to improve equity (eg.taxes, welfare benefits)
• regulatory
the creation and enforcement of laws around markets and the
behaviour of producers and conusumers in markets (e.g. Fair Trading Act, Consumer Guarantees Act)
• stabilisation
economic polices aimed at sustained, long-term economic growth (e.g. monetary policy)
MARKET FAILURE (3.4)
Equity and Efficiency
The effectiveness of any government policy can be judged against two criteria - efficiency and
equity.
Efficiency
This refers to allocative efficiency, i.e. supply and demand are working effectively
to maximise consumer and producer surplus. However our definition of allocative
efficiency must include the wider impact of goods and services on society, i.e.
the social costs and benefits of producing or consuming goods or services such as
pollution, crime, etc.
Equity
Equity is when people have the same chance or opportunity to succeed, i.e. when
things are fair. This does not mean that everyone gets the same income or outcomes
- that’s equality. Equity means that everyone gets the same chance and is treated
fairly.
Figure 1.3 ... Black Markets
A black market is one that exists illegally. They are markets where someone chooses to produce or provide a
good or service that the government has banned or that the government allows only under very tight controls
(including sales taxes). Typical examples include markets for guns, illegal drugs, stolen goods, etc.
In one sense these markets are very efficient . . . consumer sovereignty is absolute. If you want any good or
service . . . and are willing to pay for it . . . someone will provide it for you. Resources have flowed to the
production of goods and services demanded by consumers!
BUT . . . often in these markets, not all of the costs of benefits to society (externalities) are considered when
individuals choose to produce (or buy) certain goods. For example, drug users consider their immediate
enjoyment of the drugs but not the cost of health-care that they may need or crimes that they may commit
to fund their habits.
19
1
1
20
MARKET FAILURE (3.4)
UNIT 1 Market Failure
Unit Content:
Understanding
1
(poor)
2
1.1 What is Market Failure?
• Back to the Beginning ... The Price Mechanism
• Market Failure
• Government Interventions to Resolve Market Failure
• Equity & Efficiency
checklist:
I have ...
 done a mind-map of the main ideas (before and after I’ve done the work)
 tried (and marked) all of the exercises
 watched the online videos of this work
 read the notes and summarised the key ideas in the margins of the pages
 made (or downloaded from quizlet) flashcards of the key ideas and definitions
relevant current events and examples:
relevant events and examples for this unit are:
I didn’t really get the following parts of this unit ...
... and I’m going to ask ___________________ to help me with this
3
(good)