Market failure CHARLENE | GCSE ECON 1 Resource allocation in market system • How does the market system distribute resources? n The market system allocates economic resources based on the interaction of demand and supply. nThe market system creates an equilibrium price and determines a quantity of output that reflects the demand and supply of producers and consumers. CHARLENE | GCSE ECON 2 Resource allocation in market system • The market system can be an efficient way of distributing resources because: n it responds quickly to changes in demand and supply n it does not need the government to manage it n it is inexpensive because it does not require government spending CHARLENE | GCSE ECON 3 What is market failure? • There are occasions, however, when the market system leads to resources being allocated in the “wrong” way. • Market failure occurs whenever a market leads to a misallocation of resources. • A misallocation of resources is means that there Market failure: when if left to the market forces of supply and demand, there is an inefficient and/or inequitable allocation of resources. may be additional costs and benefits to society that are not included in the market equilibrium price. CHARLENE | GCSE ECON 4 Examples of market failure • For example: n some goods and services, such as healthcare and education, may not be consumed or produced in large enough quantities to maximize the benefits to society. merit goods n other goods and services, such as unhealthy foods, may be overconsumed and overproduced, resulting in additional costs to society. demerit goods nsome goods and services that benefit society, such as street lighting or national defence, may not be provided at all. CHARLENE | GCSE ECON public goods 5 Examples of market failure 1. 2. 3. 4. 5. 6. Missing market for public goods Externalities Underconsumption of merit goods Overconsumption of demerit goods Information failure Misallocations in non-competitive market CHARLENE | GCSE ECON 6 Missing market for public goods CHARLENE | GCSE ECON 7 Public goods • Non-rival (non-diminishable) in consumption: p the consumption of a product by one person does not reduce the amount available to others. • Non-excludable: p non-payers cannot be prevented from Public goods: are products that are nonrival in consumption and non-excludable. using the product. CHARLENE | GCSE ECON 8 Public goods • Examples for public goods? Non-rival in consumption? Non-excludable? Ice cream Crowed sidewalk National Defense Cable TV CHARLENE | GCSE ECON 9 Public goods • Examples for public goods? Non-rival in consumption? Non-excludable? Ice cream × Private goods × Crowed sidewalk × Quasi public goods √ National Defense √ Public goods √ Cable TV √ Quasi public goods × CHARLENE | GCSE ECON 10 Missing market for public goods • In free market, is there any one that wants to buy or sell such goods? Why? p No. p Since one person pay for it and the others can also benefit from it for free, nobody wants to pay for it. p Also no one wants to sell. p Missing market CHARLENE | GCSE ECON 11 Missing market for public goods • Why a missing market for public goods is a kind of market failure? p There is demand for public goods because they are beneficial to consumers p But firms are unwilling to supply, and no consumers want to buy p Inefficient allocation of resources - market failure CHARLENE | GCSE ECON 12 Missing market for public goods • Since no private sector wants to sell or buy public goods, who will get involved? p government will intervene the market -- state provision of public goods CHARLENE | GCSE ECON 13 Externalities CHARLENE | GCSE ECON 14 Externalities • Other names of externality: p side-effects p spillover effects • Third parties: p someone that is not involved in the transaction • Externality can be the result of: p consumption or production • Externality can be: p good (positive) or bad (negative) CHARLENE | GCSE ECON Externalities: effects on third parties due to the consumption or production of goods and services. 15 Four situations of externalities negative positive CHARLENE | GCSE ECON production consumption negative externalities in production negative externalities in consumption positive externalities in production positive externalities in consumption 16 Examples • Negative externalities in production n production of clothes causing water pollution Negative externalities in production occur when the production process results in harmful effects on third parties. • Positive externalities in production n When farmers plant fruit trees, bee keepers also get benefit. Positive externalities in production occur when the production process results in beneficial effects on third parties. CHARLENE | GCSE ECON 17 Examples • Negative externalities in consumption n smoking Negative externalities in consumption: occur when the consumption process results in harmful effects on third parties. • Positive externalities in consumption n listening to pleasant music Positive externalities in consumption: occur when the consumption process results in beneficial effects on third parties. CHARLENE | GCSE ECON 18 Activity • Write down positive or negative externalities associated with the following objects. n Car n Factory n Park or green space n Education materials n Hospital n Cell phone CHARLENE | GCSE ECON 19 Private costs vs. social costs • When social costs are greater than private costs • The difference between social costs and private costs is • external cost • negative externality • How to calculate social costs? • SC = PC + EC CHARLENE | GCSE ECON Private costs: the costs to those involved in a transaction, the costs to the consumers and firms involved. Social costs: the costs or harmful effects to those involved in the transaction (consumers and firms) and to any third parties affected. 20 Private benefits vs. social benefits • When social benefits are greater than private benefits • The difference between social benefits and private benefits is • external benefits • positive externality • How to calculate social benefits? • SB = PB + EB CHARLENE | GCSE ECON Private benefits: the benefits to those involved in the transaction, the benefits to the firms and consumers involved. Social benefits: the benefits or beneficial effects to those involved in the transaction and to any third parties affected. 21 Social optimum • When all the social costs and benefits are taken into account, the social welfare can be maximised. Social optimum: the quantity that maximises social welfare and reflects the social costs and benefits of an activity. CHARLENE | GCSE ECON 22 Why externalities are market failure? • However, when private sectors (buyers and sellers) make decisions, which benefit or cost will they consider? p Private benefits p Private costs CHARLENE | GCSE ECON 23 Why externalities are market failure? • Firms will produce more goods with negative externalities compared with social optimal - overproduction • Market failure CHARLENE | GCSE ECON 24 Why externalities are market failure? • Firms will produce less goods with positive externalities compared with social optimal - underproduction • Market failure CHARLENE | GCSE ECON 25 Why externalities are market failure? • Consumers will consume more goods with negative externalities compared with social optimal - overconsumption • Market failure CHARLENE | GCSE ECON 26 Why externalities are market failure? • Consumers will consume less goods with positive externalities compared with social optimal - underconsumption • Market failure CHARLENE | GCSE ECON 27 Under-consumption of merit goods Over-consumption of demerit goods CHARLENE | GCSE ECON 28 Merit and demerit goods • The word “judge” implies how we can classify a merit or demerit good? p value judgement - views of what is good or bad, right or wrong p what are merit or demerit goods will vary between countries, according to moral or political judgement. CHARLENE | GCSE ECON Merit good: a product that society or government judges is desirable, too little is provided by the market for the benefit of society as a whole. Demerit good: a product that society or government judges is undesirable, too much is provided by the market for the benefit of society as a whole. 29 Merit and demerit goods • Compared with public goods, the market for merit and demerit goods are facing partial market failure p missing market for public goods p merit goods could be provided through the market p but not enough to maximise social welfare. p demerit goods are provided p but too much to maximise social welfare CHARLENE | GCSE ECON Merit good: a product that society or government judges is desirable, too little is provided by the market for the benefit of society as a whole. Demerit good: a product that society or government judges is undesirable, too much is provided by the market for the benefit of society as a whole. 30 Merit goods and positive externalities in consumption • Examples of merit goods? p education p health care • A merit good can bring p private benefits to the individual consumer p external benefits to third parties from their use CHARLENE | GCSE ECON 31 Merit goods and positive externalities in consumption • Explain why education is a merit good? p A good education can allow an individual to get a more highly paid job. ü private benefits to the individual consumer p They will therefore pay more tax, creating additional revenue for the government. Also, education will create a more highly skilled workforce that will help the economy to grow. ü external benefits to third parties CHARLENE | GCSE ECON 32 Demerit goods and negative externalities in consumption • Examples of demerit goods? p cigarettes p junk food • A demerit good can bring p private costs to the individual consumer p external costs to third parties from their use -- negative externalities CHARLENE | GCSE ECON 33 Demerit goods and negative externalities in consumption • Explain why junk food is a demerit good? p It is food that can cause health problems if it is eaten too frequently. ü private costs to the individual consumer p Eating too much junk food can create costs to the economy, because people may work less if they are ill. Also, an unhealthy diet may increase medical burden to the society. ü external costs to the third party CHARLENE | GCSE ECON 34 Imperfect information can affect provision of merit and demerit goods • Underprovision of merit goods and over provision of demerit goods may result from imperfect information. p people may not know the full or long-term effects of actions they take now p sometimes even people know the long-term effects, they may ignore them (myopic (short-sighted), focusing on short-term satisfaction or utility, not taking account of the long-term costs and benefits) p merit goods tend to be underconsumed and underprovided p demerit goods tend to be overconsumed and over provided CHARLENE | GCSE ECON 35 Costs to society of merit and demerit goods • The consumption of demerit goods can lead to negative impacts on society, such as increased healthcare costs for the government or reduced economic growth due to lower productivity. • Underconsumption of merit goods, such as education, may lead to increased inequality. In the market without government intervention, not everyone may be able to afford education. Those who consume less education may have less chance of securing a highly paid job. CHARLENE | GCSE ECON 36 Imperfect information CHARLENE | GCSE ECON 37 Information failure • Information failure is where individuals or firms have incomplete or inaccurate information, resulting in wrong decisions. • Imperfect information exists when buyers and/or sellers do not have all the necessary information to make the correct decision about a product. • Asymmetric information is a form of imperfect information where one party (usually the seller) has more or better information than the other (usually the buyer). CHARLENE | GCSE ECON 38 Information failure • How imperfect information leads to market failure? nExample 1: when a student does not know the long-term benefits of obtaining further qualifications, they may not focus on studying hard at school. Such merit goods (education) are therefore underconsumed and underprovided. nExample 2: users of cigarettes may not know the likelihood of developing smoking-related diseases later in life or they may choose to ignore this information. These demerit goods are therefore overconsumed and overprovided. CHARLENE | GCSE ECON 39 Information failure • How asymmetric information leads to market failure? nExample: when selling a second-hand car, the seller has far more knowledge of its quality than the buyer. This makes it difficult for buyers to make rational decisions and is a possible cause of information failure and market failure. CHARLENE | GCSE ECON 40 Misallocations in non-competitive markets CHARLENE | GCSE ECON 41 Misallocations in non-competitive markets • Examples of non-competitive markets? p Oligopoly p Monopoly • Firms in a non-competitive market tend to set higher price or lower price? p higher p For example, a producer in a monopoly could limit supply by lowering its production. CHARLENE | GCSE ECON 42 Misallocations in non-competitive markets • Non-competitive markets have low levels of competition, which may reduce the standard of living of consumers. • For example, a firm in a non-competitive market may seek, to reduce competition by temporarily selling at a lower price than its rival producer, driving them out of the market, reducing consumers’ choice. CHARLENE | GCSE ECON 43 Government intervention to reduce market failure CHARLENE | GCSE ECON 44 Methods of government intervention to counter market failure • If a government thinks that a market has a misallocation of resources, meaning there is market failure, it may decide to intervene in the market. • The government may decide to influence the market price of a product or how much of the product is produced. The government may even decide to ban the product altogether. • Other methods of government intervention attempt to change people’s attitudes and behaviour, so that they change their consumption patterns. CHARLENE | GCSE ECON 45 Methods of government intervention to counter market failure • Do you know any methods a government can use to correct market failure? • regulation • government provision • correcting information failure • indirect taxation • subsidies CHARLENE | GCSE ECON 46 Regulation • Regulation includes rules and laws to correct market failure. • e.g. banning a demerit good completely • e.g. passing a law to make it more difficult to buy or supply the good. (restrictions on the sales and uses of fireworks) merit goods • e.g. passing a law to make everyone must be vaccinated against a demerit goods particular disease • e.g. compulsory labeling of nutritional information on food and drink CHARLENE | GCSE ECON information failure 47 Government provision • Some goods or services such as public goods may be underprovided or not provided at all, by the market system. • When this happens, the government may decide to organize for the product to be provided. The government can either provide the product itself or arrange for another organization to produce it on behalf of the government. • It can then decide how to fund these goods or services, such as through taxation or charging consumers for their use. p e.g. government provision of education and policing. CHARLENE | GCSE ECON 48 Correcting information failure • Information failure may lead to overconsumption or under consumption of certain goods or services, because consumers are not fully aware the harm or benefit to themselves and to society caused by their use. • Correcting information failure involves trying to change people’s attitudes to consuming a product. • e.g. The government might discourage the consumption of junk food by using an advertising campaign showing the harm that it causes to the body. CHARLENE | GCSE ECON 49 Indirect taxation • If a government wants to reduce the consumption or production of a certain product, for example a demerit good, it might achieve this by placing a tax on the firms that make this good. • A tax on good or service is known as an indirect tax. Having to pay this tax would increase the producers’ costs of production. CHARLENE | GCSE ECON 50 Indirect taxation • If demand for the product is price elastic, then the reduction in quantity will be relatively greater than the percentage increase in price. • If demand for the product is price inelastic, then the reduction in quantity will be relatively smaller than the percentage increase in price. • This shows that an indirect tax will be more effective in reducing consumption of a good or service if demand is price elastic. CHARLENE | GCSE ECON 51 Subsidies • If a government wants to increase the consumption or production of a certain product, then it might achieve this by granting a subsidy to the firms that make this good. • A subsidy means that money is given to producers to lower their costs of production. Producers will be more willing to supply their goods. CHARLENE | GCSE ECON 52 Subsidy • If demand for the product is price elastic, then the increase in quantity will be relatively greater than the percentage decrease in price. • If demand for the product is price inelastic, then the increase in quantity will be relatively smaller than the percentage decrease in price. • This shows that a subsidy will be more effective in increasing consumption of a good or service if demand is price elastic. CHARLENE | GCSE ECON 53 Thank you for your attention! CHARLENE | GCSE ECON 54
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