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CH4A: Market Failure and Government Intervention Part 1, case study:…

- - - - c. pursuit of self-interest
        
        economic activities are driven by self-interest.
        
        each unit in the economy attempts to do what is best for itself
        
        firms aim to maximise profit, consumers aim to maximise satisfaction and workers aim to get jobs that yield as high a return as possible
        
        all these lead to the maximum good for society
      - d. perfect competition
        
        larger amount of buyers and sellers
        
        each having an insignificant share of the market and they have no influence on the market demand and supply
        
        no single buyer or seller is influential enough to control the market and exploit other sellers and buyers
      - b. freedom of choice and enterprise
        
        consumers are free to dicide what to buy with their income
        
        workers are free to choose where and how much to work
        
        firms are free to choose what to sell and what production methdos to use
      - e. price mechanism at work
        
        the decisions of producers determine the supply of a commodity while those of buyers determine demand.
        
        the interaction of demand and supply determines the equilibrium price.
        
        price: (1) allocate resources to production; (2) to act as an apportioning device
      - a. private ownership of property
        
        individuals have the right to own, control, dispose of land capital and natural resources
        
        have the right to the incomes earned from the use of the factors of production
    - - distributive function: correcting inqequity
      - allocative function: correcting allocative inefficiency
      - stabilistaion fuction: correcting instability
      - Growth function
    - - definition: market failure exists when the free market fails to allocate resources in an efficient manner
        
        both allocative efficiency and productive efficiency must be met for the market efficiency to be achieved
        
        another goal is equity, which can be defined as fairness in the distribution of economic welfare
      - main sources of market failure
        
        iii. merit and demerit goods
        
        iv. amrket dominance
        
        ii. externalities
        
        v.information failure
        
        i. public goods
        
        vi. factor mobility
- - - - non-excludability
        
        where it is not possible to provide a good or services to only one person without it thereby being available for others to enjoy
        
        it is technically impossible or economically unfeasible to exclude anyone from the benefits of the good once it is provided
        
        non-paying users cannot be excluded from enjoying a public good, suppliers will find it difficult or impossible to collect fees for the benefits they provide.
        
        e.g., street lamp: once it is being provided, it would be extremely costly, if not impossible, to switch the street on whenever a payer walks under the lamp and switch it off when a non-payer walks underneath it.
        
        it is thus impossible to prevent a passer-by from seeing the light.
        
        once it is provided, it will benefit everyone who walks under it, irrespective of whether the person has paid for it or not.
        
        since non-payer can also enjoy the benefits, this would deter people from deciding to pay for it in the first place
        
        thus not provided by private produces
        
        free-rider problem: an individual is able to enjoy benefits from the consumption of a good or service without having to pay for the consumption of the good or service
      - non-rivalry
        
        the consumption of the commodity or service by an individual does not deplete the benefits available to others to enjoy
        
        the consumption of the good by one person does not reduce the benefit of the good available to others
        
        e.g., when one person walks under the street lamp, the level of brightness will be the same as when two or three poeple were to walk under it. The level of brightness deos not ducrease with increasing number of poeple walking under it.
        
        additional user does not deplete the supply of a public good and the marginal cost of providing for an additional user is 0.
        
        with MC=0, the basic principle of optimal allocation (i.e. P=MC) calls for provision of public goods and services at no charge.
        
        No private firms are willing to provide the goods at price=0
        
        if provided by private firms, they would charge a price above 0, and hence P＞MC, allocative efficiency cannot be achieved
- - - - this results in a divergence between marginal private cost and marginal social cost (due to marginal external costs)
        
        e.g. bad drain smell, sleep deprivation due to a neighbour listening to loud music late at night
      - 7 steps to explain on negative externality diagram:
        
        (1) in the market, as producers are self-interested, they will only consider their marginal private benefit (MPB) and marginal private cost (MPC) and produce at MPC=MPB to maximise their profits
        
        (2) In this case, MPB is ..., MPC is ...
        
        (3) the production of the good generates external costs to third parties such as ... (e.g. discharging the pollutant into the ocean and kills the fishes )
        
        (4) due to the presence of external costs (MEC), there is a divergence between the marginal private cost (MPC) and marginal social cost (MSC), where MSC=MEC+MPC. Assume the external benefit is negligible, then MSB=MPB as MEB=0
        
        (5) when left to a free market, the private producers will produce 0QP units of the goods where MPC=MPB. However, the socially optimal level of production would be where MSB=MSC at the level of 0QS units. Producers fail to internalise the external costs
        
        (6)since QP＞QS, there is an overproduction of goods which leads to allocative inefficiency. society will be better off if fewer goods are produced. At QP, the marginal social cost is higher than the marginal social benefits, this means the society values the benefits of production of the 0QP the unit of goods less than what it costs society to produce it. Market failure.
        
        (7) the additional cost of overproducing is QSE1AQP, while the additional benefit of overproducing is QSE1E0QP. the welfare loss to society due to overproduction is represented by E1AE0 in the figure. cause a deadweight loss to society
      - govenment intervention
        
        market based solutions
        
        a. taxation
        
        specific tax at a socially optimal level of output
        
        aim to make the offending firms internalise the external costs
        
        limitations:
        
        problem assessing the exact monetary value of the external costs at the socially optimal level of output. level of taxation is hard to determine. too high will lead to a less than optimal level of output and too low will lead to overproduction.
        
        administrative costs of collecting tax may be very high. firms may also have incentives to evade such taxes
        
        unintended consequences. good with price-inelastic price would lead to lower-income groups have to pay more due to tax. as an increase in price only lead to less than proportionate demand decrease, low-income groups have to spend more on the goods
        
        benefits:
        
        shift the MPC curve upwards to (MPC+tax), which coincide with the socially optimal output at E1
        
        no overproduction, allocative efficiency is attained
        
        removal of DWL, correct market failure
        
        give incentive for firms to conduct R&D/find cleaner ways of production to reduce marginal external costs
        
        source of revenue of government, use for R&D to reduce pollution
        
        b. tradable permits
        each firm is given a permit to produce a given level of pollution/use of natural resources. if it requires less than what it is given, the credit can be sold to another firm that exceeds its original limit.
        
        benefits:
        
        internalise the external costs of polluting
        
        simple: the government only have to determine the total amount of permitted discharge, without specific knowledge of the specific cost and benefits of individual firms
        
        firms will have incentives to reduce their pollution level and sell their excess permits
        
        firms with high pollution will find it more economical to buy the permits than implementing the pollution control measures
        
        limitaions:
        
        give firms the 'right to pollute' is not morally right
        
        increasing pollution as firms will not implementing pollution contorl measure but instead buying permits, so they do not have incentive ot reduce pollution
        
        hard to decide how to allocate the permits to firms
        
        high administraitive cost as govenment have to track and monitor the amount of pollution produced by each firms.
        
        possible that dominant firms buy up all the permits and refuse to trade, which act as a barrier to entry, contribute to non-competitiev behaviour.
        
        C. quotas
        
        set the level of consumption or production of an activity or good to the socially optimal level, achieving allocative efficiency
        
        case study on Quotas:
        
        non-market based solutions
        
        a. legislation or government regulation
        
        controlling through laws and administrative rules
        
        prohibit or regulate behaviour that imposes an external cost, e.g., forcing potential polluters to bear the cost of more proper disposal of industrial wastes.
        
        force potential offenders to bear all the costs associated with their production so polluting firms will internalise the external costs.
        
        benefits::
        
        simple and clear
        
        limitations:
        
        enforcement of law can be difficult and expensive as agencies have to check factory by factory, firm by firm
        
        for a law to be effective, the penalties should be sufficiently harsh
        
        the methods to control pollution may be costly and must be included as part of the social cost of production
        
        firms have no incentive to reduce pollution further than what is required by the law
        
        b. education campaigns and advertisement
        
        allow the external cost from consumption of such goods to be made known to the individuals
        
        consumption of these goods would be discouraged due to a change in tastes and preference
        
        benefits
        
        no extra cost needed
        
        shift the MPB curve to coincide with the MSC at the social optimal output level
        
        limitations:
        
        the effectiveness is uncertain and difficult to measure.
        
        effectiveness depends on individual
        
        takes a long term to be effective, cannot be used if the problem is urgent and must be dealt within the short run.
    - - 7 steps to explain on positive externality diagram:
        
        (1) in the market, as producers are self-interested, they will only consider their marginal private benefit (MPB) and marginal private cost (MPC) and produce at MPC=MPB to maximise their profits
        
        (2) In this case, MPB is ..., MPC is ...
        
        (3) the production of the good generates external benefits to third parties such as ... (e.g. vaccination prevents the third parties such as family members from falling sick, and reduce work absenteeism which contributes to the nation's productivity)
        
        (4) due to the presence of external benefits (MEB), there is a divergence between the marginal private benefits (MPB) and marginal social cost (MSB), where MSB=MEB+MPB. Assume the external cost is negligible, then MSC=MPC as MEC=0
        
        (5) when left to a free market, the private producers will produce 0QP units of the goods where MPC=MPB. However, the socially optimal level of production would be where MSB=MSC at the level of 0QS units. Producers fail to internalise the external costs
        
        (6)since QP＜QS, there is underconsumption of goods which leads to allocative inefficiency. society will be better off if more goods are consumed. At QP, the marginal social cost is lower than the marginal social benefits, this means the society values the benefits of production of the 0QP the unit of goods more than what it costs society to produce it. Market failure.
        
        (7) the additional cost of overproducing is ..., while the additional benefit of overproducing is .... the welfare loss to society due to overproduction is represented by ... in the figure. cause a deadweight loss to society
      - govenment intervention
        
        market bases solutions
        
        a. subsidies
        
        including mass immunisation programme
        
        indirect on firms and direct on consumers stimulate either MPC or MPB respectively
        - e.g. direct subsidy: shift the MPB upward; indirect subsidy: shift the MPC downwards
        
        efficiency is achieved
        
        direct:
        
        indirect:
        
        benefits:
        
        removal of DWL, reach socially optimal level of output
        
        allocative efficiency
        
        limitations:
        
        difficult to acess the exact monetary values of the MEB
        
        increase govenment expenditure
        
        non market base solutions
        
        a. legislation
        
        relatively easier to implement
        
        e.g. compulsory eductaion
        lim: constant checking is required
        
        b. direct provision
        
        government provision
        
        e.g. provision of primary school education, government provide school buildings and hiring teachers
        
        can control the quantity immediately to the socially optimal level of output
        lim: greater inefficiency due to lack of competitive pressure and the profit motive.
        government increasing fund and expenditure
        
        c. joint provision
        
        government employ private firms to carry out parts of the provision of the goods with positive externalities while it remains as the sole provider
        
        e.g. train services
        
        government can control and monitor the price and quantity, increase to the socially optimal level of output.
        
        more incentive and pressure for increasing efficiency
        lim: face difficulty in monitoring and enforcing the quantity standards.
        increasing fund and expenditure of government
        
        d. eudctaion campaigns and advertisement
        
        benefits:
        
        encourage the consumption or production of such goods by informing then benefits of the good
        
        limitations:
        
        effectiveness is uncertain as this is on a purely voluntary basis.
        
        depend on individual receptiveness
        
        cost for education and advertisement can be high
        
        limited effect in short term