Market failures

Market Failure

Defintion

market failure is a situation in which the production and allocation of goods and services is not efficient.

Types of market failures

Productivity inefficiency

When a firm doe snot produce at the lowest unit cost.

Pareto inefficiency

The economy is not producing maximum possible output because it is not on the PPF and therefore not fully exploiting it's resources

X inefficiency

Occurs when a firm is not producing at its maximum output. (Usually occurs in highly uncompetitive markets where there is no incentive to do so)

Allocative inefficiency

Occurs when the consumer does not pay an efficient price

The marginal cost of production is not covered by the price paid by consumers.

Social inefficiency

The marginal private costs do not take the costs borne to third parties in account

Occurs when the social costs of production are not regarded

Monopoly Power

A pure monopoly is defined as a single supplier in a market.

Monopoly 'power' occurs when there are only few suppliers in a market or when certain firms are the price-takers

occurs rarely

Leads to:

Less Choice

Higher Prices

Lower Consumer Surplus

Restricted Supply

Productive and Allocative inefficiency

Missing Markets

Negative Externalities

The failure of producing goods and services that are need ed and wanted but not provided

Often public goods

It is a cost suffered by a third party as a result of an economic transaction

It is an external cost

MSC is greater than MPC

Unstable markets

Some markets need intervention to be stabilised

They suffer from three problems

Falling long-term income

Unstable prices

Loss of bargaining power

Remedies

Using Price Mechanism

Changing the behaviour of consumers and producers

For Example: Increasing the price of harmful products

Legalisation and Force

The use of force of the law to change unwanted behaviour

Example: Banning cars from city centres

Social Education

Educate users about demerit goods

Government Intervention

The government intervenes to prevent market failures

Minimum prices

Here goods cannot be sold at a price below this. Minimum prices are set above the market price, so supply will exceed demand, resulting in a glut or surplus.

Buffer Stocks

uses a price ceiling and a price floor

If the price becomes too high, the government or buffer stock authority release the good onto the market from storage

The government or buffer stock authority purchases large quantities of the good and stores it, to reduce the supply available to the market so raising the market price

Subsidies

State Provision

Regulation

Pollution Permits

Private and Public Goods

Public goods

Public Goods often lead to Market Failures

Two important concepts when we are thinking about classifying goods as private or public goods are the concepts of rivalry and excludability.

A good is rivalrous if one person consuming it ‘uses it up’, meaning someone else cannot consume it

A good is excludable if you can prevent somebody from using it

Private Goods

Private goods are rivalrous and excludable, although sometimes the government provides publicly provided private goods

Free Rider Problem

If you can’t exclude somebody from using the good, then if one person privately provides the good, everybody else enjoys the same benefit, but does not have to share in the cost

this incentivises people to not pay for provision of the public good, in the hope that others will do so.

Examples: Education, Street Lamps,