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market failure - Coggle Diagram
market failure
Merit and Demerit Goods:
Government may think that some consumers are unable to act in their own best interests.
--> Government wants to encourage the consumption of merit goods and discourage the consumption of demerit goods.
Merit Goods: goods in which the state believes will be underconsumed if left to the free market as some indiciduals are unable to factor in the full private benefits of consumption
Perceived Private Benefit< Actual Private Benefit
Demerit Goods: goods in which the state believes will be overconsumed if left to the free market because some individuals are unable to factor in the full private costs of consumption
Perceived Private Cost< Actual Private Cost
Rationale: ignorance, irrationality and irresponsibility.
Inperfect Information:
one of the reasons contributing to market failure arising from externalities, merit and demerit goods
Negative externalities and demerit goods: some consumres may be unaware or they may underestimate the harm done to others or themselves.
Positive externalities and merit goods: some consumres may be unaware or they may underestimate the benefits enjoyed by others and by themselves respectively.
Policies for different situation:
Giving consumers better access to relevant info
-->Mandatory labelling of info such as power consumption for electrical devices, fuel consumption for cars.
-->Raise awareness through compaigns
Consumers end up buying something that is not really what they want or need.
-->Laws protecting consumer rights
Difficulty in acquiring accurate pricing info from sellers.
--Policies that enable greater access to pricing info e.g. requiring all retailers to explicitly display their prices.
Externalities:
Definition: Externalities refer to the spill-over effect on third parties arising from the production and consumption of a good
Classification: Negative externalities(adverse effects) and positive externalities(benefits)
Policies to manage Positive Externalities:
Subsidies: The government can improve social outcomes by providing subsidies to raise its production or consumption
-->Per unit subsidies: Raise the profitability and lower the price of a good, thus stimulating its production or consumption
-->Lump sum subsidies(grants): Used when the government wants a specific action to be undertaken.
Free vs Partial Provision:
-->Free provision: entire cost is financed by the state
When positive externalities are extensive, free provision is preferable.
When positive externalities are limited, partial subsides is preerable.
Policies to manage Negative Externalities:
-->Market-based approach: Taxing the output/externality
-->Command approach/direct controls:Quantity controls(quotas&bans)
-->Combination of market and command approaches:Tradeable permits
-->Creating public awareness
Comparing Policies for managing Negative Externalities:
-->Targeting of externality vs output:
Policies which taget the externalities are in generally preferable to policies which target outpu but targeting output is a more practical solution since externalities are difficult to measure.
-->incentive for long run externality abatement:
taxing the externality provides long run externality abatement incentives as compared to direct controls. Tradable permits system creates some long run incentive but this will diminish over time. Public awareness does provide abatement incentives if economic agents can be sufficiently alerted.
-->Certainty in outcome:
direct control>market-based approaches(regulators need to monitor and adjust). Public awareness only has generally low certainty.
Market Dominance:
When a market is dominated by one firm(monopoly) or a few firms(oligopoly), competition is limited
Characteristic:
Consumers lack alternatives
Firms are easier to collude and set a high price
Firms tend to be complacet
-->Less likely to minimise cost
-->Less innovation through R&D(research&development
Policies to manage market dominance:
Antitrust(anti-monopoly) legislation
-->Prevent firms from merging or acquiring rival firms or break existing firms into smaller entities
-->Penalise and stop firms from engaging in anti-competitive actions
Drawback: consumers can receive better quality from large firms
Price controls
-->Prices are set or approved by regulatory bodies
Drawback: it is hard for regulators to set right price
Nationalisation
-->The good or service is provided by a government organisation
Drawback: government agencies have other social objectives such that they cannot put a lot of budget on non-profit deal
Public Goods
In the case of Public Goods, total market failure arises because such goods will never be supplied under a free market
Characteristics:
-->Not possible to prevent a person who has not paid from consuming the good
-->The consumption of the good by a person does not diminish the quantity or quality available to others
Non-Excludable,Non-Rival!
Government failure refers to the situation where government intervention worsens rather than improve overall outcome and can be the result of imperfect info, excessive administrative costs or political influences.
Definition: the situation where the free market fails to achieve an outcome that maximise society's welfare.
Types of market failure:
1.Externalities
2.Merit and demerit goods
3.Imperfect information
4.Market Dominance
5.Public goods
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