Uploaded by Sarah Scheckner

Market failure

Market failure
Positive externalities
Marginal Social Benefit (MSB)> Marginal Private Benefit (MPB)
We consume where MSC (S) meets MPB(D) = not socially efficient ->
potential welfare gain -> underallocation of resources
How can the gov. achieve the potential welfare gain?
it will want to increase the consumption of merit goods (good that ppl need) which
have a significant positive externality
- subsidies (or direct provision): encourages producers to produce more and
shifts MSC downwards to reach the efficient level of consumption.
Problem? Gov. has a limited amount of $$ and resources so creates
an opportunity cost.
- improving on info about the benefits of a product through public awareness
campaigns: consumers have imperfect info about benefits of consuming a
merit good. This would shift the MPB move to the right towards the MSB curve
which would increase welfare. Problem? advertising costs money, has minimal
effect on the short run but may be beneficial long term
- legislation: gov. could pass laws insisting that citizens, for example, get vaxed.
-> only works if it is free of charge Problem? people often resent these laws and
see it as an infirgement of their civil liberties
Where MSB = MSC -> socially efficient
How can the gov. achieve the potential welfare?
- subsidies: subsidise to firms that offer training (in this example) and MPC would
shift downwards by the amount of the subsidy
Problem? 1) hard for gov. to estimate the level of subsidy deserved by every firm
2) cost of subsidy creates an opportunity cost
- direct provision: provides vocational training throughout the state (in this
example) Problem? cost is high, trainers might not be good, .....
To be socially efficient MSB=MSC
Negative externalities
MSB<MPB (example: people who smoke enjoy the benefits of smoking but everyone
else suffers the consequences (second hand smoke)) -> there is a welfare loss to
society which creates a market failure
to maximize private utility and consumer at a level where MSC=MSB
DEMERIT GOODS: harmful to consumers because people are unaware or ignore
the risks, gov will try to lower the quantity to reduce the welfare loss (cigs, alcohol,..)
How can the gov. reduce/eliminate welfare loss?
- market based approach = indirect taxes: tax will reduce consumption. Problem?
if PED is inelastic then D won't change, if the price increases then people will go
and buy where it is cheaper so the gov will miss out on tax revenue, it can be
regressive as it often impacts low income ppl.
- legislation/regulation: "command and control", people may oppose the laws, if
it is effective then the producers are hurt (can lead to lobbying), can be difficult
to enforce
- education/raise awareness: education system (can be a long term solution)
which shifts the MPB to the left. Problem? -> costs, doubt of effectiveness
(behavioural problems)
- consumer nudges: gets consumers to reduce consumption voluntarily
related to environmental problems.
international agreements: - gov. plays a role with their own contributions, - human
impact = economic activity, - Paris agreement
tradable permits: - market based approach, - gov. body sets a max of ie: fish to be
caught -> divides the resource sup and allocates the total amount into individual
amounts, - creates a market for the permits, - the effectiveness can depend on
many things (inclusiveness of the scheme, see page 146)
carbon taxes: - is imposed when fossil fuels are burned, is a market based
legislation and regulations: - gov. can set regulations to prevent the
neg.impacts. at a market based approach: permits+taxes
command and control: gov regulations, can have problems (see pg 149) such
as corruption and lobbying
subsidies: - subsidies for renewable energy sources and makes them more
"Collective self-governance": Tragedy of the common (users of a resource will
act out selfishly) -> privatise land, gov takes over management of resources. often
common pool resources