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Chapter 10 + 11: Market Failure and Government Intervention (4 types of…
Chapter 10 + 11: Market Failure and Government Intervention
Benefits of competitive market
Allocative efficiency:
Marginal benefit = Marginal cost
Surplus is maximized
Productive efficiency:
output is produced at the minimum of average total cost
Externality
Positive externality (i.e: academic research)
Social value > Private value or
Social Marginal Benefit > Private Marginal Benefit
The optimal quantity > The equilibrium quantity
To
internalsing an externality
, government might give
subsidy
Negative externality (i.e: congestion, pollution)
Social Cost > Private Cost
The optimum quantity < The equilibrium quantity
To
internalising an externality
, government might put some
tax
on the producers
Definition: where the person's activity effects the wellbeing of a bystanders
Definitions
Excludable:
the property of a good wherby a person can be prevented from using it
Rival in consumption:
the property of a good whereby one person's use diminishes other people's use
Market failure
: when a market does not result in an efficiency allocate outcomes
4 types of goods
Private goods
Common resources: are not excludable but rival in consumption (i.e: fish in ocean).
Non- excludable => uder production
Public goods and its problems
Non- excludable: can't charge for product or service and there will be free riding leading to
under production
Non- rival: goods will be under consumed if charge for
Club goods: excludable but not rival in consumption (i.e: fire protection, satellite television).
Non- rival => under consumption
Solutions to negative externalities
Private solutions
Charity
Scholarship
Integrating different types of businesses
Moral codes and social sanctions
The Coase theorem
(contracts between interested parties)
If private parties can bargain
costlessly
over the allocation of resources, then they can solve the problems of externalities on their own
Conditions for Coase theorem
Efficacy of bargaining - no transactions costs (i.e: do not need to hire lawyers)
Effective legal system that can implement and enforce contracts
Public policies
Command and control policies:
Regulation (i.e: maximum residue limits on chemicals in agriculture)
Market- based instruments
Price
based instruments
Tax on negative externalities. If the tax per unit = amount of external cost => can reach the
quantity optimum
Subsidy on positive externalities
Quantity
based instruments (i.e: emissions permit)
Government set a
quantity
that
limits
allowable emissions in a certain area and they allow
permits
to be
traded
Information failure and preference failure (merit goods)
Markets and supply of information
Markets do not generate information in an optimal way
Examples: knowledge is non- rival in consumption and has positive externalities => firms are likely to
under- invest in research or knowledge
Asymmetric information
(see the ppt for more details)
Solutions for information failure
(must see the table in ppt)
Merit goods
Compulsory education and seat belts: government considers individuals should consume even though they do not demand
De- merit goods
(alcohol, tobacco): government considers individuals should consume in
smaller amounts