Market Failure
Market Failure
• Definition:
• Where the market mechanism fails to
allocate resources efficiently
– Social Efficiency
– Allocative Efficiency
– Technical Efficiency
– Productive Efficiency
Market Failure
• Social Efficiency = where external costs and
benefits are accounted for
• Allocative Efficiency = resources cannot be
readjusted to make one consumer better off
without making another worse off – zero
opportunity cost! P = MC
• Technical Efficiency = production of goods and
services using the minimum amount of resources
• Productive Efficiency = production of goods and
services at lowest factor cost
Market Failure
• Market Failure occurs where:
– Knowledge is not perfect – ignorance
– There is resource immobility
– There is monopoly power
– Services/goods would or could not be
provided in sufficient quantity by the market
– External costs and benefits exist
– Inequality exists
Market Failure
• Imperfect Knowledge:
– Consumers do not have adequate technical
knowledge
– Advertising can mislead or mis-inform
– Producers unaware of all opportunities
– Producers cannot accurately measure
productivity
– Decisions often based on past experience
rather than future knowledge
Market Failure
• Resource Immobility
– Factors are not fully mobile
– Labour immobility – geographical and
occupational
– Capital immobility – what else can we use the
Gautrain for?
– Land – cannot be moved to where it might be
needed, e.g. Orange River to Lainsburg
Market Failure
• Monopoly power
– Produces less than the social optimum
– Deadweight loss under monopoly
A monopolist producing less than the social optimum
R
MC
P1
MC1
AR
MR
O
Monopoly output
Q1
Q
A monopolist producing less than the social optimum
R
MC = MSC
P1
P2 = MSB
= MSC
MC1
AR = MSB
MR
O
Monopoly output
Q1
Q2
Q
Perfectly competitive output
Market Failure
• Monopoly power
• The demand curve under monopoly
– production at less than the social optimum
• Deadweight loss under monopoly
– consumer and producer surplus
• consumer surplus
Market Failure
• Monopoly power
• The demand curve under monopoly
– production at less than the social optimum
• Deadweight loss under monopoly
– consumer and producer surplus
• consumer surplus
• producer surplus
Market Failure
• Monopoly power
• The demand curve under monopoly
– production at less than the social optimum
• Deadweight loss under monopoly
– consumer and producer surplus
• consumer surplus
• producer surplus
• total surplus
Deadweight loss under monopoly
R
MC
(= S under perfect competition)
Consumer
surplus
a
Ppc
Producer
surplus
AR = D
O
Qpc
(a) Industry equilibrium under perfect competition
Q
Market Failure
• Monopoly power
• The demand curve under monopoly
– production at less than the social optimum
• Deadweight loss under monopoly
– consumer and producer surplus
• consumer surplus
• producer surplus
• total surplus
– the effect of monopoly on total surplus
Deadweight loss under monopoly
R
Pm
Ppc
MC
(= S under perfect competition)
Consumer
surplus
Deadweight
welfare loss
b
a
Producer
surplus
AR = D
MR
O
Qpc
Qpc
(b) Industry equilibrium under monopoly
Q
Deadweight loss under monopoly
R
MC
(= S under perfect competition)
Perfect
competition
Consumer
surplus
a
Ppc
Producer
surplus
AR = D
O
Qpc
(a) Industry equilibrium under perfect competition
Q
Deadweight loss under monopoly
R
MC
(= S under perfect competition)
Monopoly
Pm
Ppc
Consumer
surplus
Deadweight
welfare loss
b
a
Producer
surplus
AR = D
MR
O
Qm
Qpc
(b) Industry equilibrium under monopoly
Q
Market Failure
• Monopoly power
• The demand curve under monopoly
– production at less than the social optimum
• Deadweight loss under monopoly
– consumer and producer surplus
• consumer surplus
• producer surplus
• total surplus
– the effect of monopoly on total surplus
• Other problems with monopoly
Market Failure
• Monopoly power
• The demand curve under monopoly
– production at less than the social optimum
• Deadweight loss under monopoly
– consumer and producer surplus
• consumer surplus
• producer surplus
• total surplus
– the effect of monopoly on total surplus
• Other problems with monopoly
• Possible advantages from monopoly
Market Failure
• Inadequate Provision:
• Merit Goods and Public Goods
– Merit Goods – Could be provided by the
market but consumers may not be able to
afford or feel the need to purchase – market
would not provide them in the quantities
society needs
– Sports facilities?
Market Failure
• Merit Goods
• Education –
nurseries, schools,
colleges, universities
– could all be
provided by the
market but would
everyone be able to
afford them?
Schools: Would you pay if the
state did not provide them?
Market Failure
• Public Goods
Markets would not
provide such goods and
services at all!
• Non-excludability – Person
paying for the benefit cannot
prevent anyone else from
also benefiting - the ‘free
rider’ problem
• Non-rivalry – Large external
benefits relative to cost –
socially desirable but not
profitable to supply!
A non-excludable good?
Would you pay for this?
Market Failure
• De-Merit Goods
• Goods which society over-produces
• Goods and services provided by the market
which are not in our best interests!
– Tobacco and alcohol
– Drugs
– Gambling
Market Failure
• External Costs and Benefits
• External costs
– The cost of an economic decision to a third
party
• External benefits
– The benefits to a third party as a result of a
decision by another party
Market Failure
• External Costs
• Decision makers do
not take into account
the cost imposed on
society and others as
a result of their
decision
e.g. pollution, traffic
congestion, environmental
degradation, depletion of the
ozone layer, misuse of alcohol,
tobacco, anti-social behaviour,
drug abuse, poor housing
External Costs
MSC = MPC + External Cost
Price
The Marginal Social Benefit
Thedifference
MPCtherefore
does
not is
take
into
TheThe
true
the
MSC
between
the
curvecost
(MSB) represents
the
account
the
cost
to
society
of
MPC
(thevalue
MPC
external
cost).
thethe
MSB
andtothe
MSC
sum ofplus
benefits
production.
At welfare
antherefore
output
level
Current
output the
levels
(100)
represents
loss
consumers
in society
as
a to
of
100,
the
private
cost
to
the
represent
some
element
of
market
society
ofthe
100private
units being
whole –
and social
supplier
is
£5
per
but the
failure
–
price
does
notunit
accurately
produced.
benefits. The Marginal
Private
cost
totrue
society
is
higher
than
reflect
the
cost
of
production.
Cost (MPC) curve represents
this (£12).
costs negative
to suppliers of
Value ofthethe
producing a given output.
£12
Social Cost
£7
£5
externality (Welfare Loss)
Socially efficient output is where
MSC = MSB
MSB
80
100
Quantity Bought and Sold
Market Failure
• External benefits
by products of
production and
decision making that
raise the welfare of a
third party
e.g. education and training,
public transport, health
education and preventative
medicine, refuse collection,
investment in housing
maintenance, law and order
External Benefits
Price
MSC
Value
externality (Welfare Loss)
£10
£6.50
There can be a position
where output is less than
would be socially desirable
(education for example?) In
this case, the sum of the
benefits to society is greater
the private benefit to the
ofthan
the
positive
individual.
Social Benefits
£5
MSB
Socially efficient output
is where
MSC = MSB
MPB
100
140
Quantity Bought and Sold
Market Failure
• Inequality:
– Poverty – absolute and relative
– Distribution of factor ownership
– Distribution of income
– Wealth distribution
– Discrimination
– Housing
Market Failure
• Measures to correct market failure
– State provision
– Extension of property rights
– Taxation
– Subsidies
– Regulation
– Prohibition
– Positive discrimination
– Redistribution of income