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CH4A: Market Failure and Govenment Intervention Part2 - Coggle Diagram
CH4A: Market Failure and
Govenment Intervention
Part2
Demerit goods
goods and services which consumption is considered to be socially undesirable, possess negative externalities and that the government feels people will overconsume, possibly due to imperfect information on the true cost to consumers themselves the goods impose
e.g. cigarettes, gambling and street drugs
e.g. cigarette
consumers are not fully aware of the long-term health implications of their consumption of cigarettes, such as smoking-related illness, medical problems and possibly death.
enjoy the thrill
MPC perceived smaller than MPC actual
MPB=MPC perceived vs MPB=MPC actual
lead to overconsumption of the good of QS and QP units
additional cost overweight the additional benefits, hence DWL and allocative efficiency
due to imperfect information ↑
due to negative externalities ↓ also need to be considered
Meirt goods
goods and services which consumption is considered to be socially desirable, possess positive externalities and that the government feels people will under consume, possibly due to imperfect information on the true benefit to consumers themselves the goods impose
e.g. education, vaccination
e.g. immunisation shot
consumers are not fully aware of the long-term benefits such as overall better health and increasing productivity at work
undervalue the MPB
MPB perceived is lower than MPB actual
underconsumption when MPC=MPB perceived instead of MPC=MPB actual
due to imperfect information
additional cost overweight the additional benefits, hence DWL and allocative efficiency
due to imperfect information ↑
due to positive externalities ↓ also need to be considered
government intervention
to improve equity, as more people have better access to merit goods such as education
the government intervention to address externalities have already being introduced in
externalities
parts
for here we only focus on imperfect information in this case
1. public eductaion
reduce imperfect information - provide imformation about the true benefits and costs to inprove their deciison making
e.g. national campaign, raido and TV broadcasting
(i) application of public education to increase consumption of merit goods
e.g. The Health promotion board organises regular health education in schools and conduct a national campaign to inform the public about the benefits of health checks and going for immunization shots
increase perceived MPB to actual MPB so increase consumption from QP to QS
(ii) application of public education to decrease consumption of demerit goods
e.g. MOH organise health education in schools and community health screening, national campaign to inform the public about the harmful effect of smoking cigarettes.
increase perceived MPC to actual MPC so decrease consumption from QP to QS
advantagement:
1. less distortion to price signals
it encourages desirable behaviours without imposing excessive costs on society or causing allocative inefficiency due to distortion of price signals. it does not affect the prices of merit or demerit goods, less likely to have over-correction of the market failure
2. low cost
relatively simple and inexpensive policy interventions
disadvantagement:
1. difficult to change or influence people' mindsets and habits
success is less certain and ineffective. depends on public's receptivity.
hard to change people's mind and habits in a short time
2. regulation (command and control measure)
directly influence people's consumption pattern by making consumption of the merit good compulsory by law or making it illegal to sell or consume demerit good.
regulate production of demerit goods: limit the nicotine and tar levels of cigarette sold locally
regulate sale of demerit goods: age restriction in buying alcohol
making consumption of merit good compulsory, e.g. eductaion and vaccination
regulate consumption of demerit goods: partial bans and total bans
improve the flow of information so that consumer are mroe fully aware of the true MPB of the good
all advertisement and TV programme that glamorise smoking and binge drinking are banned
conpulsory text and pictures in health warning message to be displayed on tbacco product packaging
market dominance
perfect competition does not always exist in reality
monopolies, oligopolies and monopolistic competition results in the 'wrong' quantity being produced at too high a price, allocative inefficient
P=MC, at QPC, the society welfare is maximised. This is known as socially optimal level of output.
however, monopoly will produce at MC=MR to maximise profit.
under-producing, allocative inefficiency, DWL.
information failure/ imperfect information
asymmetric information:
is a case where one party in the market - either the consumers or producers - has more information about the product than the other resulting in a distortion of incentives and inefficient market outcomes
adverse selection:
occurs when asymmetric information between buyers and sellers of a product causes one of the parties to make suboptimal choices that results in lower welfare and thus the inefficient market outcome
a. the used car market
sellers have more information (know what exactly is wrong with their car)
to profit, sellers may hide some information
potential buyers consider this, so more likely to lower the price that they are willing to pay
at lower prices, sellers with used cars in good condition are unwilling to offer the cars for sales
resulting in cars with low quality are sold
proportion of poor quality cars in the used car market will be higher than good quality ones
the change of a potential buyer getting a poor condition used car are higher than a used car of good condition
results in adversely selecting against high quality used cars
buyers often end up buying a lower quality car at a higher price than what they would have been willing to pay if they had perfect information
marginal benefit of buying the used car would be lower than marginal cost
of the car
welfare loss and market failure
will fail completely when buyers will not want to buy cars from the used car market for fear of purchasing a car that is of poor quality
b. insurance market
consumer may not share sufficient and accurate information about their health condition with insurance companies
insurance companies being unable to adequately monitor the behaviour of those who seek insurance coverage
companies risk providing insurance coverage to those with higher health risks
consumers with higher risk are more likely to buy insurance since they have a greater risk of falling ill
if insurance rates are set at the same level for everyone, it is a better deal for those who are unhealthy than those who may never make medical claims
unhealthy people are more likely to buy insurance, the proportion of unhealthy people in the pool of insured people increases
insurance companies suffer loss
if they have perfect information, they would charge higher premiums for those unhealthy people
insurance companies raise their premiums to cover their losses, which forces the price of insurance to increase.
more healthy people will be aware of their low risk of falling sick and choose not to buy insurance at all.
further increase the proportion of unhealthy people among the insured
fail completely when the companies do not want to sell health insurance to unhealthy people as they are becoming unprofitable
no provision of such goods in society
solutions to overcoming adverse selection
(2) signals
actions taken by informed parties to reveal private information to un-informed parties.
e.g. offer a warranty which guarantees that for the next six months the seller will fix any defects in the car.
this is a signal that this car is in good condition, otherwise, the seller would not dare to provide such a costly warranty
(3) screening
uninformed party to induce an informed party to reveal information.
e.g. buyer can ask a mechanic to check the car before purchase.
e.g. medical examination before insurance
(1) incesting in information
information provided by independent parties
e.g., the buyer can read up on the general information on different models and brands of cars or make use of the Internet to find out the prices or getting a mechanic to inspect the car before purchasing it.
(4) laws
e.g. 'lemon law': replacement or repair of a product whose defect surfaces within 6 months of purchase, failing which, a price reduction or full refund would be required.
moral harzard
: the situation in which economic agents take greater risks than they normally would because the resulting costs will not be borne by them, but instead the cost is shifted onto the other party
insurance contract
e.g. a shop owner who does not take due care in order to prevent a fire from occurring because he knows his insurance will cover the costs should a fire break out.
he will have less incentive to take care of his shop to prevent fire
insurance companies will increase the premiums, marginal cost higher than marginal cost, market failure
solutions
incentives
deductibles: the initial amount of money that insure party needs to pay before the insurance company covers the rest.
lower premiums or discounts for those with a good track record.
increase incentive and precaustions
factor mobility
refers to the inability of a factor of production to shift from one use to another, even in response to large changes in demand and remuneration
1. occupational immobility
some capitals are occupational mobile: such as a computer which can be put to productive use in many different industries
some are designed for specific industry hence are immobile.
labour being occupational immobile can result in unemployment or being used in a way that is not economically efficient
Workers retrenched from the declining textile industry may have job-specific skills that are not necessarily transferable to expanding industries such as aerospace, and may not be able to acquire skills needed for such a transfer (known as structural unemployment)
2. geographical immobility
lack of preparedness of poeple to move within countries in response to change in the labour market either due to social (e.g. family ties) or financial factors (e.g. high cost of relocation, higher cost of living)
why a market failure?
the economic system has to respond to a rapidly changing economic environment by reallocating resources. factor immobility prevents the switch to the production of new goods and services most valued by society, in the quantity required.
thereby allocative inefficiency and productive inefficiency.
solutions?
improving the information flow (privide job information for both labour and companies)
training of workers through skills upgraidng programme
government failure
problems created by intervention may could be greater than problems overcome by that intervention
c. lack of market incentives
e.g. subsidy, provision of welfare, guaranteed prices and wages
subsidies may allow inefficient firms to survive
welfare payments erode or discourage the incentive to work
lack of profit motive - inefficiency
d. shifts in government policy creating uncertainties in the market
if intervention changes too frequently, economic efficiency may suffer and firms may find it difficult to plan
b. bureaucracy, time lags and inefficiency
waste of number of people and material resources in the process of intervention
tends to be bureaucratic, with elaborate and rigorous procedures to follow and long decision-making processes before decisions can be made. time lags
e. myopic decision-making
tend to consider short-term solutions to correct market failure instead of well-considered, long term solutions
temporary relief but not address structural problems
a. imperfect information (asymmetric information)
may not know the full cost and benefits of policies
e.g. don't know the exact value of tax to impose
f. pursuit of self-interest
some politicians may implement policies for their self-interest instead of the benefit of citizens
misallocation
e.g. reduce taxation in the run-up to an election
