Market Failure Solutions
Negative Externalities
Positive Externalities
Public goods
Imperfect Information
Income inequality
Market dominance
Imperfect mobility of factors of production
Deregulation To subject firms to greater competition so as to keep the price more competitive and improve efficiency
Regulations Pricing of goods by monopolies can be monitored closely by the government
Pricing policies (price ceilings) The maximum price a firm can charge is dictated by law so that large firms are unable to charge higher prices
Limitations
1) Government failure may occur as they may not know the exact price that equals to the marginal cost due to insufficient information. They may end up over or under stating the price, leading to greater inefficiency in allocation of resources 2) With a decrease in profits, firms may be not incentivized to conduct R&D, lowering dynamic efficiency
Progressive taxes and tax on luxury goods so that higher income earners pay more tax
Minimum wage to protect the income of low-wage workers
Supply side policies such as education and retraining of workers to increase value of low-wage workers
Limitations 1) Cause unemployment and retrenchment 2) Illegal employment at an even lower wage
Limitations 1) Long gestation period 2) Success is dependent on the age, attitude and aptitude of the workers
Limitations 1) May reduce incentive to work and hence hinder potential growth of the economy 2) High tax rates may discourage firms from investing, implicating economic growth negatively 3) The demand for luxury goods is price elastic in demand and price inelastic in supply. Hence, the tax burden is on producers who may hire lower factors of production once demand falls, and increase in income inequality instead as it is mostly lower-income workers who are working for these firms
To overcome occupational immobility: implement supply side policies such as retraining and education
To overcome geographical immobility of labour : Build better infrastructure and transport lines
To overcome geographical immobility of capital: The government can target certain sectors and encourage firms to purchase capital goods by giving incentives such as tax rebates.
Limitations 1) There are other factors that influence firm's decision to purchase capital goods such as business sentiments and stability
Limitations 1) Success depends on age, attitude and aptitude of workers
Limitations 1) Long gestation period is needed an is not useful in the short term
There are regulations that require firms to provide accurate and sufficient information of products to consumers
Education is a long-term solution to raise awareness of the negative or positive externalities to correct perceived benefits or costs.
The government can provide directly by either producing the goods and services themselves or by outsourcing to a private company with the objective of maximizing society's welfare
Limitations 1) Lack of information such as actual level of public demand for the public good. 2) Electoral pressures and conflicting interests due to the pursuit of self-interest among politicians.
The government can provide directly by either producing the goods and services themselves or by outsourcing to a private company with the objective of maximizing society's welfare.
Providing subsidies 1) Subsidies cause producers and consumers to internalize positive externalities by decreasing cost of production so that MPB shifts to coincide with MSB. 2) Amount of subsidies per unit output must be equal to MEB. 3) This serves as an incentive to produce more to the socially optimal output
Limitations 1) Lack of knowledge and information regarding the amount of subsidies to provide. Government failure 🔥 may occur in the event of over/under subsidizing. 2) Subsidies increase income inequality as they may increase the producer's profits. 3) Subsidies may breed inefficiency in the long run as it reduces the incentives for firms to stay efficient by find the lowest cost of production.
Education : A long-term solution to raise awareness among consumers and producers of the negative externalities present in the products through campaigns, education in schools and advertisement.
Limitations 1) Education is a long process dependent on the age, attitude and aptitude of the recipient. 2) It may be difficult to change habits and mindsets
Regulations : Firms may be prohibited by law from producing more than the socially optimal output.
Limitations 1) The government may fail to get firms to comply with the law. 2) Legal restrictions are blunt instruments and fail to incentivise firms to further reduce output in the case of pollutions. ⭐CARBON TAX ⭐ 3) High adminstration cost and enforcement difficulties hinder the success of this intervention method. 4) Penalties must be sufficiently harsh, but estimation of harshness is difficult.
Total Ban on product The government can set a total ban on a product if the welfare loss is deemed to be far greater than the social benefits. This eradicates all negative externalities arising from the product. E.G Chewing gum
Limitations 1) High adminstrative cost and enforcement difficulties hinder the success of this intervention method. 2) It may work against the welfare of the society if the ban results in greater welfare loss.
Marketable Permits 1) The government can auction off marketable permits, with the number of permits decided beforehand. 2) Firms can buy and sell these permits according to their production level. 3) The higher the price of a permit, the greater the incentive for the firms to reduce pollutive emissions and other forms of negative externalities ⚠Emission Trading Scheme ⚠
Limitations 1) Government failure may occur as the government may inaccurately determine the correct number of permits to auction off. 2) There is difficulty of withdrawing the permits once issued. 3) It is difficult to determine the price of permits, as the government may end up over/under charging, which may still result in the inefficient allocation of resources. 4) High administrator costs and enforcement difficulties hinder the success of this intervention method.
Implementing taxes 1) Taxes causes producers to internalize negative externalities by increasing the cost of production so that MPC coincides with MSC. 2) Tax per unit output is equal to MEC. 3) This serves as an incentive to lower output to the socially optimal output Qs
Limitations 1) Lack of knowledge and information regarding the amount of tax per unit output to impose. Government failure may occur in the event of over/under taxing. 2) Different tax rates imposed on different firms producing different levels and types of externalities is unfeasible and inefficient. 3) High taxes on goods that have highly price-elastic demand are unpopular. 4) Administrative costs to collect taxes