2.8: Market Failure - Externalitites And Common Pool Resources Flashcards
Market failure definition
- 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
Market failure results in
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
Positive externalities
Advantages or gains of production/consumption to a third party not involved in an economic transaction
Marginal private benefit (MPB)
Additional value enjoyed by households and firms from the consumption or production of an additional unit of output
Marginal private cost (MPC)
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
Marginal social benefit (MSB)
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
Marginal social cost (MSC)
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.
Socially optimal level of output
Marginal social benefit = marginal social cost
Positivé externalities occur when
Marginal social benefit > marginal private cost
Negative externalities occur when
Marginal social benefit < marginal private benefit
Examples of goods with positive externalities
- law and order
- emergency services
- national security
- sewage and disposal systems
- education
- healthcare
Merit goods
- Goods that create positive externalities when produced or consumed.
- can be rivalrous and/or excludable
Negative externalities
Expenses incurred by third parties not involved in an economic transaction for which no compensation is paid
Negative externality of production
- MSC > MPC
- at Qe: MPC = MPB
- Qopt: MSC = MSB
Common pool resources
- not owned by any private individual or firm
- do not have a price
- ## vulnerable to overuse and abuse
Characteristics of common pool resources
1) non-excludability
2) rivalrous
3) tragedy of the commons
Non-excludability
Not possible to prevent those unwilling and unable to pay for teh service from using and benefitting from it
Rivalrous
The consumption of a resource reduces the quantity of that resource available to others
Tragedy of the commons
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
Types of government response to externalities and common pool resources
(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
Pigouvian taxes
- indirect taxes
- internalize the externality
- shifts the supply curve, causes price to rise and quantity demanded to contract
Advantages of pigouvian taxation
- increases price therefore decreasing quantity demanded and limiting the externality
- creates tax revenue that internalizes the externality
Disadvantages of pigouvian taxation
- 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
Carbon text
- similar to pigouvian tax but on carbon emissions
- identifies teh price of emissions and imposes it on polluters
- creates incentive to reduce pollution
Legislation and regulation
- 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
Disadvantages of legislation and regulation
- 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
Education and awareness
- shifts demand curve from MPB to MSB
- funding costs may lead to deadweight loss
Advantages of awareness and education
- behavior and consumption patterns may change
- cultural shifts for the better
- long term impact
Disadvantages of education and awareness
- campaigns may be ineffective
- work in the long run, not the short run (change takes time)
- opportunity cost of govt spending
Tradable permits
- 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
Benefits to cap and trade schemes
- 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
Arguments against CATS
- 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
International agreements
- 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
Collective self governance
- 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
Limitations of subsidies to correct market failures
- difficult to set an precise subsidy to ensure optimal allocation ESP as social return is hard to measure and can be subjective
- opportunity cost
Government provision limitations
- economic inefficiency and potential over consumption
- opportunity cost
- issues of inequality (who gets access in a shortage)
Strengths and limitations of government policies approaches
1) challenges in the measurement of externalities
2) degree of effectiveness
3) consequences for stakeholders
Challenges involved in measurement of externalities
- how to assign value to incalculable things i.e noise pollution or free elementary
Degree of effectiveness of govt policy
- 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
Consequences of govt policy on stakeholders
- 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
