2.8: Market Failure - Externalitites And Common Pool Resources

Question 1

Market failure definition

Answer 1

• Market failure occurs when the signally government, incentive and rationing functions of the price mechanism fail to operate optimally, leading to a loss in economic welfare.
• From society’s perspective, there is a misallocation of scarce resources
• market fails to consider externalities

Question 2

Market failure results in

Answer 2

1) under-provision of merit goods and services
2) over-provision of demerit goods and services
3) over-consumption of demerit goods and service
4) under consumption of merit goods and services

Question 3

Positive externalities

Answer 3

Advantages or gains of production/consumption to a third party not involved in an economic transaction

Question 4

Marginal private benefit (MPB)

Answer 4

Additional value enjoyed by households and firms from the consumption or production of an additional unit of output

Question 5

Marginal private cost (MPC)

Answer 5

Additional expense if production for firms, or the extra charge paid by consumers for the production or consumption of an additional unit of output.

Note: MPC = supply

Question 6

Marginal social benefit (MSB)

Answer 6

Total gains to society from the production or consumption of an additional unit of output. The sum of the benefits for private firms and households + the positive externalities to others

Question 7

Marginal social cost (MSC)

Answer 7

Total expense to society from the consumption or production of an additional unit of output, including both private or direct costs to producers and consumers + all negative externalities.

Question 8

Socially optimal level of output

Answer 8

Marginal social benefit = marginal social cost

Question 9

Positivé externalities occur when

Answer 9

Marginal social benefit > marginal private cost

Question 10

Negative externalities occur when

Answer 10

Marginal social benefit < marginal private benefit

Question 11

Examples of goods with positive externalities

Answer 11

• law and order
• emergency services
• national security
• sewage and disposal systems
• education
• healthcare

Question 12

Merit goods

Answer 12

• Goods that create positive externalities when produced or consumed.
• can be rivalrous and/or excludable

Question 13

Negative externalities

Answer 13

Expenses incurred by third parties not involved in an economic transaction for which no compensation is paid

Question 14

Negative externality of production

Answer 14

• MSC > MPC
• at Qe: MPC = MPB
• Qopt: MSC = MSB

Question 15

Common pool resources

Answer 15

• not owned by any private individual or firm
• do not have a price
• ## vulnerable to overuse and abuse

Question 16

Characteristics of common pool resources

Answer 16

1) non-excludability
2) rivalrous
3) tragedy of the commons

Question 17

Non-excludability

Answer 17

Not possible to prevent those unwilling and unable to pay for teh service from using and benefitting from it

Question 18

Rivalrous

Answer 18

The consumption of a resource reduces the quantity of that resource available to others

Question 19

Tragedy of the commons

Answer 19

Degradation, depletion, destruction of a common access resource caused by overuse, abuse or overconsumption

• mentality of: If i dont take it, someone else will so I might as well benefit

Question 20

Types of government response to externalities and common pool resources

Answer 20

(Acronym= PIGLETS CC) 
P- pigouvian taxes 
I - international agreements 
G - government provision 
L - legislation and regulation 
E - education and awareness 
T - tradeable permits 
S - subsidies 
C - carbon taxes 
C - collective self governance

Question 21

Pigouvian taxes

Answer 21

• indirect taxes
• internalize the externality
• shifts the supply curve, causes price to rise and quantity demanded to contract

Question 22

Advantages of pigouvian taxation

Answer 22

• increases price therefore decreasing quantity demanded and limiting the externality
• creates tax revenue that internalizes the externality

Question 23

Disadvantages of pigouvian taxation

Answer 23

• demand for demerits tend tp be inelastic
• as a regressive tax, it can more heavily impact low income households and firms
• encourages smuggling and unofficial markets

Question 24

Carbon text

Answer 24

• similar to pigouvian tax but on carbon emissions
• identifies teh price of emissions and imposes it on polluters
• creates incentive to reduce pollution

Question 25

Legislation and regulation

Answer 25

• laws on the use of scarce resources = legislation
• regulation = management of complex rules, laws and policies firms must comply with
• shift the demand curve from MPB to MSB

Question 26

Disadvantages of legislation and regulation

Answer 26

• can cause underground markets where demerit goods can be purchased, consumers scammed
• penalties may not be high enough to deter
• governement cost to maintain monitoring

Question 27

Education and awareness

Answer 27

• shifts demand curve from MPB to MSB

- funding costs may lead to deadweight loss

Question 28

Advantages of awareness and education

Answer 28

• behavior and consumption patterns may change
• cultural shifts for the better
• long term impact

Question 29

Disadvantages of education and awareness

Answer 29

• campaigns may be ineffective
• work in the long run, not the short run (change takes time)
• opportunity cost of govt spending

Question 30

Tradable permits

Answer 30

• Government regulated emissions trading schemes using a market based approach to reduce production to a more socially optimal level
• regulator steps a cap/ limit on emissions and issues permits in accordance
• permits can be freely traded

Question 31

Benefits to cap and trade schemes

Answer 31

• reduce carbon emission, raise government revenue
• quantity supplied is fixed, as demand increases price will increase forcing firms to invest in cleaner energy
• larger polluters must purchase more permits, making them less competitive

Question 32

Arguments against CATS

Answer 32

• anti-competitive, especially for smaller firms
• can cause unemployment due to high production costs
• multinational enterprises can shift production to nations w/o CATS
• environmentalists argue not drastic enough as demand is inelastic and consumption has not sufficiently decreased
• industry cap can bee too high eg, china cap is 5 billion tons

Question 33

International agreements

Answer 33

• bilateral or multilateral agreements
• legally binding
• acc international environmental agency, more than 3000 international agreements have been registered
• eg Kyoto protocol, paris accords, COP agreements
• hold countries to account
• no enforcement

Question 34

Collective self governance

Answer 34

• voluntary communal actions to combat the problems of negative externalities and rage problems associated with exploitation of common pool resources and the tragedy of the commons
• voluntary tikes and community agreed sanctions and consequences
• local communities make more informed policy choices

Question 35

Limitations of subsidies to correct market failures

Answer 35

• difficult to set an precise subsidy to ensure optimal allocation ESP as social return is hard to measure and can be subjective
• opportunity cost

Question 36

Government provision limitations

Answer 36

• economic inefficiency and potential over consumption
• opportunity cost
• issues of inequality (who gets access in a shortage)

Question 37

Strengths and limitations of government policies approaches

Answer 37

1) challenges in the measurement of externalities
2) degree of effectiveness
3) consequences for stakeholders

Question 38

Challenges involved in measurement of externalities

Answer 38

• how to assign value to incalculable things i.e noise pollution or free elementary

Question 39

Degree of effectiveness of govt policy

Answer 39

• not always clear if intervention effective, sometimes only evident in the long run (i.e awareness on cig consumption)
• govt policy can be limited lags, cost of enforcement, conflicting values of policy makers

Question 40

Consequences of govt policy on stakeholders

Answer 40

• large corporations employ market power be relocating to other countries
• ## government regulation favors large companies with the fiscal resources to comply, smaller businesses face greater economic challenge