12. Market failure

Question 1

Define market failure

Answer 1

MARKET FAILURE: when supply does not meet demand and the resources are allocated inefficiently

Question 2

Types of market failure

Answer 2

1. Lack of public goods
2. Under-supply of merit goods
3. Oversupply of demerit goods
4. Existence of externalities

Question 3

Define public goods

Answer 3

PUBLIC GOODS: goods that would not be provided at all in a free market

Question 4

Market failure: lack of public goods, explain

Answer 4

• public goods benefit to society, so lack is considered failure, ex: national defence, flood barriers
• quasi public goods: public goods but also can be supplied in free markets, ex: street lighting, lighthouse
• public goods not supplied in free market because: non-excludable (all benefit), non-rivalrous (one person consumes it, does not rpevent other person from consuming it)

Question 5

How gov can interve to solve market failure: lack of public goods

Answer 5

• gov provide public goods themselves
• subsidise private firms to supply

Question 6

Market failure: under-supply of merit goods, explain

Answer 6

• gov thinks that merit goods bring positive benefits for people and whole society - should be consumed at a greater degree
• all public goods are merit goods (education, health, sports, opera)
• depending on the importance of merit good, gov can completely finance some goods but also in cost of taxpayers, less important - subsidise

Question 7

Define merit goods

Answer 7

MERIT GOODS: goods which are under-suplied by the market therefore they are under-consumed

Question 8

Market failure: over-supply of demerit goods

Answer 8

Demerit goods - overprovided - overconsumed goods

• gov thinks they are bad for people and society - want to decrease consumption (cigarettes, alcohol)
• depends on how harmful - drugs - illegal, not that harmful - taxed - cigarettes, alcohol

Question 9

Market failure: existence of externalities

Answer 9

Externalities - consumption/production effects on third parties

Both positive and negative

Externalities exist when: MPC=/MSC and MPB=/MSB

Question 10

Define externality

Answer 10

EXTERNATILITY: occurs when consumption of production of a good or service has affects to third parties

Question 11

Types of externalities

Answer 11

1. Neg extern. of production (external costs)
2. Neg. extern. of consumption
3. Pos. extern. of production (external benefits)
4. Pos. extern. of consumption

Question 12

Explain negative externalities of consumption (external costs)

Answer 12

Usually relate to pollution: factories pollute air - additional costs for the society - MSC > MPC of production

Gov intervene to eliminate market failure:

• tax firm for pollution to increase production costs - gov internalise externality BUT hard to determine how much pollute
• could ban polluting firms / restrict their output - increase private costs BUT decrease job positions
• gov could issue tradable emission permits - limited permits - can buy/trade them between firms - can create certainamount of pollution: cap and trade system (ex chlorofluorocarbons in US controlled by tradable emission permits, Kyoto protocol issues for green house gases GHG)

Question 13

Explain positive externalities of production

Answer 13

• ex: firm provides high quality training, looks after health at private cost

Gov could decrease market failure by:

• subsidise the firms taht offer psoitive externalities to reduce MPC BUT difficult to estimate level of subsidy, opportunity cost - reallocate its spending
• provide vocational training in training centres in trageted industries BUT high costs

Question 14

Explain negative externality of consumption

Answer 14

• ex: cigarettes - secondary/passive smoking, cars - air pollution, alcohol - MPB>MSB

Gov act to eliminate negative externality:

• ban the consumption of good or in certain areas BUT on burden on stakeholders
• impose indirect taxes (on price) BUT inelastic demand - bought anyways, deter only young smokers, black market
• provide education about harm of those goods BUT high costs and doubtful if effective

Question 15

Explain positive externalities of consumption

Answer 15

• ex: education, healthcare - no disease spread, MSB > MPB

Gov intervene:

• subsidise, provide the goods BUT high costs - reallocate speniding
• positive advertising to encourage consume BUT high costs, long-term effects
• pass laws ex people vaccinate BUT civil liberties

Question 16

Diagram of reducing market failure (pos ext of consumption)

Answer 16

Question 17

Define common acess/common pool/common property resources

Answer 17

typically natural resources such as fishing grounds or forests. Probelm with them - very difficult/expensive to exclude poeple from using them - overconsumption - depletion of resources

Question 18

Define marginal utility

Answer 18

MARGINAL UTILITY: extra satisfaction that a person gets from consuming one more unit of good or service

Question 19

Define sustainability

Answer 19

SUSTAINABILITY: where consumption needs of current generations are met without limiting the future generations to meet their needs

Forms: over-exploitation, pollution, corrosion, land degradation, deforestation, use of fossil fuels

Sustainability is in danger in poverty and in economic growth

Question 20

Governememnts responses to sustainability threats

Answer 20

1. Cap and trade system: tradeable emssion permits
2. clean technologies: renewable E - solar panels, wind farms
3. Subsidise sustainable businesses