Market Failure And Externalities Flashcards
1
Q
Why may the market fail
A
If less than optimum allocation of scarce resources resulting in a welfare loss in society
2
Q
Productive efficiency
A
Producing goods and services at the lowest possible cost
3
Q
Allocative efficiency
A
The goods and services match the wants and needs of consumers
4
Q
Externalities
A
By product from the production and consumption that affects a 3rd party for which no compensation is paid
Eg. Pollution factories(production) or car driving (consumption)
Cigarettes- passive smoking,
5
Q
Mpc
A
Marginal private cost
Cost to an individual or firm
Eg. Car manufacturing components
6
Q
Mec
A
Marginal external cost
Cost to 3rd parties
Eg. Pollution- cost cleaning up
7
Q
Msc
A
Marginal social cost
Overall cost to society
Msc= mpc+ mec
8
Q
Mpb
A
Marginal private benefits
Benefit to an individual ir firm
Eg., car manufacturer- profit
9
Q
Meb
A
Marginal external benefits
Benefit to 3rd parties
Eg, employment. Tax revenues
10
Q
Msb
A
Marginal social benefit
Overall benefit to socity
Msb= mpb + meb
Mpb+ externalities=msb
11
Q
What should ideally take place
A
Msb=msc
Cost=benefit
-allocative inefficiency
12
Q
Demerit good diagram
A
Mpb above msb line
Private to private and shade
13
Q
Merit good diagram
A
Msb above mpb
Private to private and draw down (left of line)
14
Q
Merit good- consumption
A
If left to the free market the social benefit exceeds the private beneift
Meaning there is a potential welfare gain to society
Merit good is undercnosumed as social optimum is msb+msc
15
Q
Polution taxes
A
Increases mpc for conusmer or producer- depends whos being taxed - decrease demand, hopefully decrease level production
-some argue that revenue from pollution taxes should be ‘ring fenced’ for the protection and enhancement of the environment
W/out taxes at q, social optimum is exceeded
16
Q
What should level of taxation ideally be
A
=external cost
Consumers pay full social cost
Tax internalise externality, bring back into price mechanism- higher cost
17
Q
How can taxation lead to gov failure
A
-right level of taxation
Consumer welfare effects
Employment and investment
18
Q
Right level of taxation- how can lead to gov failure
A
So private cost is exactly equated with social cost, insufficient or too excessive
19
Q
Consumer welfare ffect- pollution taxes
A
Producer may pass on tax to consumer fi demand is inelastic
Therfore tax has small effect on reducing demand
Regressive efect lower incomes
20
Q
Employment and investment- pollution taxes
A
If polution taxes increase one can producer may move to country wiith lower taxes- structural unemployment
21
Q
Pros of industry regulation- demerit
A
Act as spur for businesses to cut co2 emissions
Regulations more effective if demand is unresponsive to tax/price changes
Can be gradually toughened each gov- helps stimulate
22
Q
Cons industry regulation - pollution
A
High cost enforcemnt/administration of laws
Can lead to unwanted consequences
Cost of meeting regulations may discourage small businesses and lower competitive in markets
23
Q
Tradgedy of the commons
A
A resource has no ownership
24
Q
Carbon trading
A
Firms buy and sell limited ability to pollution
Caps made by countries- incentive to produce less
Pollute over fine- pollute under- can sell
25
Carbon trading- failq
Corruption and fraud- how much pollution varies
Set by individual countries- requires international cooperation
26
Lack of property rights
Opportunism- individuals/groups exploits lack of private consumption
Free rider problem- price mechanism less effective as private goods that can be stolen
Misuse of scarce resources- eg. Dropping litter or deliberately spilling oil
Moral hazard- someone elses problem
Over use resources- general exhaustion of natural resources inc. environment
Limited development- according to hernando de soto
27
Extending property rights
Gov grants property rights over scarce resources in attempt to protect them from opportunism
Assume property oweners have greater knowledge
28
Pros- extend property rights
Gov doesnt have access to lack of property- asured knoweldge owner knows more
Direct trasnfer of resources from polluters to those who effected
Without regulation those who suffer dont recieve compensation
29
Cons- extend property rights
Gov may not have ability to extend property rights eg, brazil deforest not stopped by uk
Large firms may have sig power and resources when it comes to court
Extending property rights within nation borders diff if link between pollution and polluters- eg, aspestos
Often diff for owener of property to assess valkue- independant valuation
30
Demerit goods
Socially undesirable creating negative externalitiies from consumptioon affecting 3rd parties
Social benefit less than private benefit
May be overconsumed if left to free market
Informaion failure may result in overconsumption- dont know about health impactq
31
Actions to tackle demerit goods
Taxation
Regulation
Minimum price
Education campaigns
Subsidise alternative
32
Taxation- demerit gods
Increase price bring extenrality back into market mechanism
Higher price- cause contraction along demand curve (s shift left)
Final demand, closer to social optimum, msb=mscq
33
Evaluation taxation for demerit
Effectiveness depends on relative elasticity
Regressive effect on society-impact lower income groups
May be unfair on consumers who take responsibility nnnot excessive
Diff to assess right value of taxes
34
Regulation - demerut
Change legislation to help reduce consumption eg. Age limits
Could also be case for complete ban if msc is always greater than msb
Eg. Drugs
35
Regulation- demerit goods- evalustion
May lead to ‘hidden markets’ which may cause other issues eg. Higher crime
Expensive for gov to administrate policing- opportunity cost for giv
36
Min price- demerit goods
Gov can get min price which is higher than min marjet price
Would reduce as the higehr price is disicnentive- alchol scotland
37
Min price- evaluation-demerit goods
Cause excessive supply
Consumers may substitute for imports- leakage circular flow
Affect on income- regressive
38
Educaton campaign- demerit goods
Decrease information failure associated with demerit goods
Should help to reduce demand closer to the social optimum
39
Evaluation education campaign- demerit goods
Cost gov money- opportunity cost
Addiction- inelastic- not be effective
Diff to implement may not reach wider audience
Audience depends on medium
40
Subsidise alternatives- demerit goods-
Gov may subsidise healthier alternatives in some cases eg, fruit juices over fizzy dribk
Would incentivise consumption of these
41
Subsidise alternatives- demerit- evaluation
Influences consumer sovereignty- freedom of choice
Cost to gov- opportunity cost
Which firm to subsidise- may distort the competitive marjet
Education may also be needed
42
Merit goods
Goods and services that if left to the free market would be underconsumed
Have positive externalities in consumption
May be information failure as people may not fullly appreciate looong term benefit of conusmption
Social ooptimum is still msb=msc
43
Micro- education merit good
Firms may sell education
Increase chance better hjobs
More productive firms increase profits
Decrease ifnormation fialure
44
Macro- education merit good
Training and education improve qualiy of workforce
More flexible labour markets
Invcrease productivity of workforce
Competitive advantage
45
Direct provusuin
Gov by-pass market
Take over responsibility of fair supply of socially efficient quantity of merit goods
Eg. Nhss
Gov could also cover some cost of private sector provision- eg. Free training healthcare- may work in provate hosputal and schools
46
What can be done to increase consumption of merit goods
Direct provision
Subsidy
Regulation
47
Direct provision- pros
Ensures fair provision for all free at point of consumption
Gov supplies socially efficient q of merit goods
More equitable
48
Direct provision- cons
V expensive for gov so gov increase tax
Disrupt free market
Deincentiveise firms- lack profit incentive
Overconsumption- nhs- if free may lead to moral hazard- more risks as not paying eg. Skiing
49
Subsidy- merit goods- pros
Decrease price so more affordable
May lead to further ‘dynamic efficiency’
Improvements of production process over time
50
Subsidy- cons- merit gooda
Expensive to cgv
May lead to subsidy capture- firms exploit gov due to informstion failure due to asymetiric info
Gov dont know exact costs
51
Regulation- pros- merit good-
May force people to consume merit goods
Eg. Car insurance legal requirement
Can police
52
Regulation- cons- merit goods
May have regressive effect- car insurance
Increase cost policing- opp cost-0 cost of admin
Diff to regulate
May lead to illegal activity
Freedom of choice
53
What are the characteristics of a pure public good
Non excludable
Non deminishable in consumption
Non rejectable
54
Non excludabel
Benefits of public goods cannot be confined to those who have paid for it
Non-payers can enjoy the benefits of consumption at no financial cost to them- free rider problem
55
Non-diminishable in consumption
Consumption of a public good by one person does not reduce the availiability of the good to others
If good is provided for one person, it must be provided for others
56
Non rejectable
If a public good is provided we cannot avoid it
57
Example of a pur public good
National defence systems
Sewage and waste disposal systems
Lighthouse
National rail safety systems
58
Moral hazard
Occurs when individuals alter behavoir because of certain gaurentees
Insure a bike- may act reclessly, not lock up, insurance company loses out as pay out more than expected
Gov may offer a gaurentee of bank deposits- could cause baank to take more risks- bail out banks
59
Refulators
Gov set up regulators to deal with natural monopolies eg. Gas and electricity
Regulator aims to get fair prices for industry and consumers
But rly on info from firm, because sympathetic to the firm and allow. Price rises
Regulatory capture- regulators act in a favourable wway to firms they are regulating
60
Free rider problem
Consumers that are unwilling to pay for pubic goods as they know they cannot be excluded from the benefits of their provision
Consumers have incentive to question ral willingness and ability to pay for public goods
They believe that they will be required/expected to contribute to financing th public good
Eg. Tv licence doges
Markets work best when g&s are private- rival and excludable
Og often financed through some form of enforcement- compulsory nature of tv licence
61
Why does the state provide public goods
Equity- all levels of incomee can access- provision on grounds of need rather than ability to pay
Efficiency- easuier to provide collectively, economies of scale from providing to all- large quantities are cheaper
Overcome free rider problem- correct for market failure- failure of markets to provide sufficient pg
62
Semi public (quasi) public goods
Public in nature but dont exhibit fully the features of non-excludability and non-rivalry
May become non-rival- eg. Peak time- congestion
Equity- gov may provide these goods directly and finance with general taxation
Element of excludability/rivals in consumption
Motorrways and major roads- congestion
Police force protection- if called to another case
63
Changing nature of public goods
Advaneces in technologyy mean the blurring of the distinction between public and private goods
Eg. Open source movement- information is a public good online
Smart electrionic toll roads- more excludable, have to pay if travel over, may be variabel prces depends on congestion- avoids free rider problem- but cause more congestion on minor roads
64
Public goods/market failure and free riders
With public goods private sector markets may fail to supply in part of in whole with optimim q of pg
Not norms providing by private sector- no profit- free rider
So not provided at all in free market- missing market
Up to gov to decide what level pg appropriate- not social benefits for making accessible
Public body- incients where no one is excluded from damage- global warming- worldwide damage
65
Information failure
Type of market failure where individuals/firms may lack info about econ decisions
66
Types of information failure
Information assymetries
Failure to disclose info
Difficulty in estimating costs and benefits
Lack of education.awareness
Framing issues
67
Information asymmatries
One party has access to info that another party doesnt
Eg. Selller of a car may knwo that it has some problem but buyer not aware
68
Failure to disclose info
Ageents may not make full fisclosure
Eg when apply for ehalth insurance fail to inform about genetic traits/current ill health
Leads to asymmetric infor
69
Difficulty in estimating costs and benefits
Often diff to be aware of social costs of goods
Accounting costs easy to know
More intangble external cost- eg. Producing energy from coal powerest station- mpc to firm- labour cost and cost of coal
But external cost- releasing co2 v diff, estimate monetary cost of pollution in both now and in the future
70
Lack of education/awareness
Merit and demerit goods decrees info failure
Consumerrs unaware true personal cost/benefit
Eg tobacco dont knwo ifll effects on health
Sugar0- unaware amount sugar in processed food, harmful effect of sugar on health
71
Framing issues
Consumers inffluenced how good is portrayed
Eg. Orange juice- healthy as vit c, but high level sugar, may hide sugar as ‘dextrose, glucose’
72
Price cieling
A price above which it is illegal to trade
Max legal prices- distort markets by creating excess demand
Households rationed by quantuty
73
Impact of price cielings
Queues and waiting lists occur
Interfere with incentive function- prevents attractiveness of new firms to market
Emergence of informal/shadow/black market
Emerge when primary//free market prevents from working properly
74
Price floors
A price below which it is illegal to trade
Creates excessive supply
Eg min wage- assume set close to ffree market level- otherwise significant increase in unemployment
75
Impact of price floors
Interfere with incentive function of prices- falling prices cause inefficient or high cost firms to leave market- prevent
May lead to increase unemployment
Cause rogue employer to break th law- paying ‘poverty wages’ to vulnerable workers such as illegal immigrants
76
Private gods
Most goods are
Excludable- private property rights prevent other people from using the good or consumers from benefitting
Rivalry/diminishability- if consumed by one, cannot be consumed by another
77
Govern,ent failure
When gov intervention in market leads to a net welfare loss and a misallocation of resources
Total social cost arises from intervention are greater than the social benefi
78
Causes of gov failure
Inadequate info
Conflicting objectives
Administration cost
Unintended consequencees
Self interest
Expertise- lack of
79
Inadequate infor
Not sufficient for politicians to make decision
80
conflicting objectives
Value judgement
Which to speend more on
Any deciison holds opportunity cost, the gov may choose which option
81
Administration ocst
Cost of gov intervention outweights the benefits
Eg gov spent 17.3bn to private sector for ppe and track and trace services which faileed to deliver
82
Unintended consequences
Law of unintended consequences- ations of consumers , producers and gov always have effects that are unanticipated or unintended
83
Self interest
Election may increase nhs spending so more popular
84
Expertise (lack of)
Subsidie capture/regulatory capture
Diff for gov to know fair prices in services where little experience
Eg. Dentistryy- patients pay too much, insufficient prices may force dentists to switch to private practise only
85
Regulatory failures
Regulators may limit innovation in fast growth markets
Change and expand, lack of competituve advantage
Capping prices may prevent new firms entering a market
Lack iincentive
Eg. From rent controls, energy price caps
Regulation becomes bureucratic and costly- menu costs
Regulator may be ‘behind the curve’ with new tecnology
May lack powers to be turley efective in protecting consumers
Frequent rule changes can shift business investment- eu laws
86
Law of unintended consequences
Well intentioned legislation often acts against intentions of those its intended to serve
People and businesses find new ways to circumvent new laws
Hidden markets may develop to undermine an official policy0- black market- drugs
87
Examples of law of uninetended consequences
Bio-fuel subsidy- may divert production awway from poorest in society-regressive effect
Import tarrifs on steel- hits domestic car and construction firms
Demerit goods- high taxes on goods such as alchol may increase demand for booze cruises abroad in france where alcohol cheaper- reduces uk tax revenue, transport increases carbon pollution, waste of resources
Landfill tax causes increase fly topping- cost to clean up and diff to prosecute
88
Negative externalities of pollution
Poor air quality
Who air pollution global public health emergency
7 million premature deaths related to bad air quality exposure occur every year
89
Costs of air pollution
Direct- healthcare costs resulting form respiratory diseases
Indirect- lost productivity from absenteeism or lower performance at work
90
Cap and trade system success
Acid rain program usa 19990s
By 2015 managed to reduce sulfur dioxide emissons by 81%
91
Other measures to reduce air pollution
London low emission zone- restrict most polluting vehicles from enternig the city centre
92
Positive economic benefits of clean air zons
Increased compettiveness, since reducing air pollutoin can make affected areas more attractive to investors
Imporeved public health and reduction in healthcare costs leading to increased econ prdoctivity and healthier workforce
Efforst to reduce air pollution can drive innovation in clen technoogies and energy rpodcution creating new eonc opp and markets
Promote sustainable development and reduce risk future enviorn and health crises and ensure lt econ stability
93
Gov failure asscoiated with price ceilings
Monopolists may over report its costs in order to amke gov impose a higher price ceiling
As well as creating excess suppply if above market equilibrium, or excess demand if below
94
Word for cant govern overseas
Territoriality of jursidiction
Esp problem climate change- uk may raise environmental taxes some of highest emitters may move to countries with laxer regulation and may even increase production,- called carbon leakage
But also if less demand fossil fuels uk due to legisltaion may result in lower cost for fossil fuels, chepaer overseas and so may icrease emissions
95
Merit good examples
Education
Healthy foods
Car insurance
96
Reasons for uderconsumption of merit godos
Information failure- unaware potential private benefit- healthy eating hwo certain foods can lead to better health or education diff see relevance of parts of curriculum to daily livs
Afford product in free market- lowering ncome not afford healthy food, most not private education
Wider benefits to society of their use of merit goods= greater overall standard of living for society as a result of higher output and increased innovatioin ans well as ghigher tax rev for gov
97
Nationalisation- shoudl it ocur
Socio econ arguments
Efficiency- against
Alternative snat
Loa- no
98
Nationalisation should- soio econ
Unemployment could increase in failing industries tata steel 2016 with 15,00 jobs risked
Lead to structural unemployment- hysterisis, higher unemployment benefits, lower tax reciepts
Thus nat could lead to inverse- positive multiplier effect- positive extenrlaities on third parties- eg multiplier ect
99
Alternatives nationalisation
Gov subsidise to reach social optimin outcome, need to be equal in size to positive externality
Yet if externality is large, better solution nat
Externalities v diff to value
Opp cost- esp if loss making firm]]
Or enable failing markets to fail such as stell, with supply side policies to pick up oiecies- occupational mobility with transferable skills, improvements geographically mobility, reducing lt and sturctural unemp
Attract fdi and other businesses to areas
Eg levelling up and northern powerhouse-e improvements infrasturcture, better access to finance, enterpsie xzones and new research centres
100
Efficinecy argument against nationalisation
Public sector statically and dynamicallly inefficient
Public sector firms may be more allocatively efficient- ie charge prices clooser mc
Public sector managers may not have experience nor incenives, lead to x inefficinecies and overstafing
No profitg motive to be dunamically efficientless comp between firms
Environmental concerns ans safety prioritise dover prodit- conflicting objectives
101
Nationalise trains essay
Probs not
Benefits consumer
-services reliable, prices, efficiency, safety prioritised as not trying to cut costs, accountable gov
Macro econ
-mobility of labour, cost of living - merited good want to increase provision better envrionmemt
Cost operations and efficiency
-privatisation would mean comp with each other- monopolyu price comp diagram comp comp price
Choice
-econ of scale less likely to be obtained- mes- as may prioirtise other things such as safety rather than cost
-may be ostly for gov too if lossmaking- coal 1946-1994
