Market failure Flashcards
The reasons for market failures
MILE 11
- Missing markets
- Imperfect competition
- Lack of information
- Externalities
- Immobility of factors of production
- Imperfect distribution of income and wealth
Discuss, in detail, Externalities
Costs not included in the pricing of goods/services
* Private costs: the cost of producing the good or service which translates into the prices that consumers pay. Also called internal costs.
* Private benefits: Internal benefits to those who produce and buy these goods, e.g. producing a bicycle (for producer) and using the bicycle (consumer).
* Social costs: these are total costs incurred by society as a whole. For example the social cost of electricity includes the cost of capital, labour, inputs and the cost of the externalities such as dirty water and air.
* Social cost = private costs plus external costs.
* Social benefits: this includes the total benefit experienced by society as a whole. For example, municipalities provide clean water to society which results in fewer illnesses. Social benefits = private benefits plus external benefits.
* Negative externalities are things like pollution, tobacco smoking and alcohol abuse. The costs of negative externalities are paid by society rather than by the producers.
* For example, Styvesant produces cigarettes, many illnesses are related to smoking. The treatment for these illnesses is paid for by society.
* Positive externalities are the positive effects of products to third parties which are not paid for.
* Negative externalities are often over-produced while positive externalities are under-produced. This leads to market failure.
Explain, in detail, Missing markets
- Markets are incomplete because they cannot meet the demand for certain goods.
- Public goods are in high demand but are not supplied by the market because of the low profit
- Since private producers cannot withhold these goods for non-payment, they are reluctant to provide these goods. The government thus provides these goods and services.
- Public goods: This includes community and collective goods and has two features:
- Non-rivalry: Consumption by one person does not reduce
consumption by another individual, e.g. a lighthouse. - Non-excludability: Consumption can’t be confined to those who pay for it (free riders can use them), e.g. radio and television.
In addition - Social benefits outstrip private benefits: e.g. health care and education.
- Non-rejectability: Individuals are not able to abstain from
consumption, e.g. street lighting. - Continuous consumption. E.g. traffic lights.
- Community goods:
These are goods such as, defence, police services, prison services, street lighting, flood control, storm water drainage and lighthouses. - Collective goods:
These are goods such as parks, beach facilities, streets. Markets are incomplete and cannot meet the demand for all goods. - Government provides public goods, which consist of:
- Merit goods: These are highly desirable for general welfare, but not highly rated by the market, e.g. health care, education and safety.
If people had to pay the market price for them, very little would be consumed. The market fails because the market produces less than the desired quantity. - Demerit goods: These are over-consumed goods, e.g. cigarettes, alcohol and drugs. Thus more of the good is produced than is socially desirable. The government bans or reduces consumption of these products through taxation, and provides information to the population on their harmful effects.
Explain, in detail, Imperfect competition?
- Competition in market economies is limited by the power of certain producers to prevent new businesses from entering the market. This is imperfect competition.
- Barriers to entry are created because of advertising, a lack of capital and the controlling of resources.
- The imperfect market doesn’t allow for price negotiations.
- Advertising is used to promote producer sovereignty (dominance), which encourages consumers to buy existing products and allows
producers to delay new products from entering the market until it is in their own interest (e.g. businesses have had the technology to produce long-life light bulbs for many years but have chosen not to launch them in the market).
Discuss, in detail, Lack of information
- Consumers: Need detailed information about goods and services. (To maximise their benefits)
- Workers: Are often unaware of job opportunities.
- Entrepreneurs: Lack of information on costs, availability and productivity of factors of production impacts their effectiveness
Explain, in detail, Immobility of factors of production
- Labour takes time to move from one area to another.
- The supply of skilled labour cannot be increased because of the time it takes to be trained
- Physical capital, like factory buildings or infrastructure such as telephone lines cannot be reallocated easily.
- Structural changes (like a change from producing plastic packets to paper packets or shifting from labour-intensive production to computer based production) requires a change in labourers’ skills, employment and work patterns. This takes time to change.
Discuss, in detail, Imperfect distribution of income and wealth
- The market produces goods and services only for those who can afford it.
- This leads to some people having too many goods while others have too few goods.
- The difference in income occurs because there is a difference in market power, unequal educational opportunities, discrimination and inheritance.
- Income distribution: The market system is neutral on issues of income distribution.
- Discrimination: Distorts earnings for women and minority groups, disabled persons and people subject to illness and incapacity.
What are the Consequences of market failures?
GIE
- Government intervention
- Inefficiencies
- Externalities
(spill-over effects)
What is meant by inefficiencies?
Two kinds of inefficiencies are possible:
* Productive inefficiency/Technical efficiency: When resources are not used appropriately to produce the maximum number of goods at the lowest cost and best quality.
* Allocative inefficiency: means that the types/quantities of goods or services produced are not what is best for consumers.
What are positive and negative externalties?
- Negative externalities:
Negative externalities bear a private cost, the cost of producing the actual product and a social cost, a cost suffered by society.
If the social cost of a good were added to the private cost of a good, the final price would be pushed up and fewer goods would be supplied.
The government has used three methods to reduce negative externalities:
* The government has carried out campaigns in order to persuade people from causing negative externalities.
* Levying taxes on goods that cause negative externalities. E.g. Taxes are levied on cigarettes and alcohol.
* Passing laws and regulations to prevent activities that cause negative externalities. E.g. Tobacco companies are not allowed to advertise. There are laws that regulates the amount of air pollution and waste.
- Positive externalities:
If people acknowledged the social benefit of a good, they would demand more of that good. The price of such a good would therefore increase.
The government encourages positive externalities by:
* Advertising on the radio or television.
* Providing education, health care and other services at a low cost or free.
* Providing consumer subsidies.
* Consumer subsidies lower the cost of a good and encourage its usage.
What are the Rules and regulations of Government intervention?
a) Direct controls - The government can pass laws or use existing legislative framework to control businesses that generate negative externalities.
b) Establishing minimum wages - When the government enforces a minimum wage, it means workers have to be paid a certain wage amount and not anything less than this.
c) Setting maximum prices/price ceilings - The government sets a maximum price ceiling below the market price to make goods more affordable.
Maximum prices allow the poor greater access to certain goods and services.
A maximum price is set on goods such as basic foods, housing and transport.
d) Setting minimum prices/price floors - The government sets a minimum price at some point above the market price.
This is done to enable producers to make a comfortable profit and thus encourages them to supply important essential goods.
- The government can use other ways to improve income distribution and overcome market failure:
- Transfers income directly to the poor e.g. child support grants,
unemployment benefits etc. - Provides goods free of charge e.g. community goods, education etc.
- Implements employment creation programmes e.g. public works
programme. - Subsidising merit goods e.g. subsidising arts and cultural events.
- Imposes taxes and laws on demerit goods to discourage
consumption. - Uses fiscal and monetary policy to achieve macroeconomic stability.
- Makes sure that consumers are informed about products through
legislation. The South African Bureau of Standards (SABS) checks
consumer goods in South Africa. - Tries to prevent misleading advertising. (Advertising Standards
Authority)
Describe, in detail, Cost-benefit analysis (CBA)
- In both private and public sectors project evaluations are done in terms of cost and benefits.
- In the private sector feasibility studies are done which also provides for legal aspects relating to externalities.
- Expected private costs and benefits are taken into account.
- In the public sector a Cost Benefit Analysis is done which takes into account expected social costs and social benefits of providing such goods and services.
What are the Reasons for cost benefit analysis?
- CBA brings greater objectivity to decision making.
- Market signals (e.g. price) help allocate resources.
- Goods supplied by the government are provided free.
- Without market signals, decisions on the desirability of a project may be subjective.
- This is done by identifying all the relevant benefits and costs of a project so that an informed decision can be made.
Applying the CBA includes
Private costs would include:
* The cost of land.
* The cost of building materials and equipment.
* Transport costs.
* Labour costs.
* Overhead costs etc.
Private benefits would include:
* Train fares.
* Subsidies from government.
* Money from allowing companies to advertise.
External costs would include:
* Pollution.
* Destruction of plants, animals and insects.
* Resettlement for people whose homes were expropriated.
* Increased traffic in certain areas and blockages of certain driving routes.
External benefits would include:
* Employment and income.
* Opportunities for new businesses.
* Time saved because of the high speed of the train.
* Fewer accidents and less traffic.
* Less strain on medical facilities.
