Download Market Failure

A.S 3.3
Describe and illustrate
resource allocation via the
public sector to compensate
market failure
Why does the government
intervene?
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The free market is not always able to achieve
allocative efficiency. – Market Failure
An allocative efficient point is where
All resources are allocated to their most efficient use
All markets are in equilibrium
The economy is operating on its production possibility curve.
It is not possible to make someone better off without making
someone else worse off (Society’s well being is maximised)
This situation is also called Pareto efficiency
We will be looking at situations where it is possible to make
someone better off without making someone else worse off.
This is when governments intervene in the market.
Conditions for the market to
achieve allocative efficiency

Requires clear price signals
There must be
 Perfect Competition
 Perfect Information
 Perfect Mobility
 Consumer Sovereignty
 No Externalities or public goods
Reading Price Signals
Market Failure

Market Failure can occur from any
of the following
 The
existence of imperfect market
structures
 Externalities
 Public Goods
 Merit and Demerit goods
 Situations where the market leads to
inequitable (unfair) outcomes
Market Failure
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Markets can fail in a number of ways
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Some products may be under produced or not
produced at all. ie parks
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Some products may be produced or over
produced but are not wanted by society
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The production and consumption of some
products affect third parties.
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ie drugs
ie pollution and smoking cigarettes.
The distribution of market income may not
enable all citizens to participate meaningfully
in society
Market Failure
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Market failure provides governments
with the reason to intervene in the
economy or in particular markets
that are failing.
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Government intervention aims to
overcome the failure of markets to
move towards a more allocatively
efficient position
Taxation
Establish
Property
Rights
Subsidies
Public Provision
Types of
Government
Intervention
Transfer
Payments
Education and
social
marketing
campaigns
Regulation
Government Intervention
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Four functions of the government
1. Legislative/Regulator Role
•
Legal Framework
•
•
Promoting Competition
•
•
Providing a framework so buyers and sellers know their
rights and obligations – enables fair dealing. Legal
system used to clarify, define and enforce property
rights.
Commerce Commission.
Correcting for externalities
Government Intervention
2. Allocative Role
Governments allocate resources that the market
fails to produce in sufficient quantities
3. Distributive Role
Governments aim to promote equity (fairness)
This may be done through redistribution of
incomes
4. Stabilisation Role
Government aims to provide a stable economic
environment
Indicate which Government
Function is being done when….
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cuts taxes to reduce unemployment
specifies that a manufacturer is liable for any harm
caused by its product
places a tax on a steel producer’s pollution
legislates that it is illegal to discriminate on the basis
of gender, ethnicity or sexual orientation
imposes a wage/price freeze
provides funding for a job search scheme
provides benefits for low income families
provides childcare funding to allow women to work
legislates to prevent misleading advertising
prevents large companies from merging
Range of Government Interventions
Method
Subsidy
Sales Tax
Income Tax
Regulations
Transfer
Payments
Public
Ownership/
Provision
Effect/ what it is Best for:
Lowering the price to encourage the production
and use of certain products. More resources are
Lowers the cost of production
allocated to a good/service than would be provided
by the free market.
Raises the price to discourage the production and
Increases the cost of
use of certain products. Pay for some of the costs
production
imposed on society as a result of the product being
consumed
Reduces Incomes
More direct effect than
taxes or subsidies
Redistribution of incomes
from “rich to poor”
Situations where its not
socially desirable for provision
to be in private ownership.
Providing G&S not
sufficiently provided by the
free market
Reduces demand. Progressive taxation narrows the
gap between rich and poor and reduces inequality
of income
Limit or prohibit the production or
consumption of certain products. Enforce the
production or consumption of certain products
Addressing income inequality in form of social
welfare benefits and income support.
Army, Police
Libraries, parks, Rubbish collection,
Education
Externalities
The are two parties in the market
• Producers and Consumer
•
Externalities are costs or benefits that
affect those other than the consumer
or producer (the third party)
•
These costs or benefits are not taken
into account in the costs of production
or consumption.
•
Externalities are also known as
“Spillovers” as the cost or benefit
spills over from the producer or the
consumer
Negative Externalities of Production

Costs that are imposed on third
parties as a result of productive
activity
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The well being of third party is reduced –
this is the cost
These costs to third parties are not taken
into account by producers and therefore no
compensation is paid
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Too much of these goods will be produced.
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The Effect of Externalities- Negative
Externalities of production
MSC
The social costs of
production are greater
than the private costs of
production
The free market will
under price and over
produce the good when
compared with the
socially desirable price
and output.
Pollution
Positive Externalities of Production
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Benefits that are gained by third parties
as result of productive activities

The well being of the third party is
increased- this is the benefit
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Producers are not able to charge for the
benefits but third parties can still enjoy
benefits for free
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As a result too little of these goods will
be produced.
The Effect of Externalities- Positive
Externalities of Production
MSC
•The social costs of
production are less
than the private costs
of production
•The free market will
over price and under
produce the good
when compared with
the socially desirable
price and output
•Tree Planting
Negative Externalities of
Consumption
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Costs imposed on third parties as a result
of consumption
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These costs are avoidable by consumers
but do not directly affect the consumer
These costs are not taken into
consideration by the consumer in the
decision making process
Too much of these types of goods will be
consumed
Can u think of some examples of
negative consumption externalities?
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The Effect of Externalities- Negative
Externalities of Consumption
•The social benefits of
consumption are less
than the private
benefits of production
MSB
•The free market will
under price and over
produce the good when
compared with the
socially desirable price
and output level
•Smoking
Positive Externalities of
Consumption
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Benefits gained by third parties as
a result of consumption
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Benefits that consumers create but
have no way of being compensated
for by those who benefit at no cost
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Too less of these goods will be
consumed as all the benefits of
consumption are not taken into
account in decision making process
The Effect of Externalities- Positive
Externalities of Consumption
•Social benefits of
consumption are
greater than the private
benefits of
consumption
SMB
•The free market will
over price and under
produce the good
when compared with
the socially desirable
price and output level
•Using public transport
Externalities
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Can u think of some examples
of negative production and
consumption externalities?
Can u think of some examples of
positive production and consumption
externalities?
The effect of externalities
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What effects our decision making
process?
Producers decisions are based on
their Marginal costs
Consumers benefit from
consumption and their decisions are
based on their Marginal benefits.
When externalities are present the
true costs or benefits to society may
not be reflected in individual MB and
MC curves.
Types of Goods
Private Goods
Mixed Goods
Public Goods
Natural Monopolies
Free Rider Problem
Merit Goods
Demerit Goods
Measures to improve
equity