Chp 4: Market Failure
Types of Market Failure
Free market fails to allocate resources in an efficient manner
Public goods
Positive Externality
Negative Externality
Imperfect Information
Information failure
Non-excludable -> Cannot exclude non-payers
Non-rivalrous -> Additional person does not deplete the supply of a good, so MC = 0 and allocative efficient price P = 0
eg. lamp post
Government has to provide public goods as private market refuses to, need to consider cost-benefit analysis
Benefit received by a third party from the production/consumption MEB
Cost beared by a third party from the production/consumption MEC
Mkt based Measures
Tradable Permits
Taxation to increase MPC
Non-Mkt based measures
Legistration
Difficult to assess exact monetary
value of MEC at Qs
Firms that incur higher costs in reducing pollution will buy the permits while others will try to reduce pollution (efficient reduction of pollution)
Dominant firms hogging the tradable permits leading to BTE
Education, Campaigns
Quotas
Prevent over production or over consumption
eg. punishing improper disposal of chemicals
No incentive to reduce pollution further than what is legal
Consumers/Producers will know about the long term costs to them, eg when polluting, the fish they eat in the future is poisonous
Illustrated by leftward shift in MPC
Time lag
Mkt based Measures
Non-Mkt based measures
Subsidy
Direct subsidy to consumers to increase MPB
Indirect subsidy to producers to lower MPC
Opp cost, Difficult to assess exact monetary value of MEB at Qs
Legistration
Need to pay for constant checking
Direct Provision
Government provides, can increase output to Qs
Lack of profit motive, Opp cost
Joint Provision
Government employs private firms to carry out parts of the provision (govt remains as the sole provider eg. LTA)
Have profit motives from firms but difficulty in monitoring and maintaining quality
Education
Market Dominance (Chp 3B)
Demerit Goods
Merit Goods
Socially undesirable, has negative externalities and imperfect information where MPC perceived is lower than MPC actual
Non-Mkt based measures
Has positive externalities and imperfect info where MPB perceived is less than MPB actual
Regulation
Public education
Low cost, Does not affect the prices of merit and demerit goods but has time lag
Need to pay for constant checking
Adverse selection
Moral Hazard
Asymmetric information leads to one of the parties making suboptimal choices that leads to lower welfare
Economic agents take greater risks than they normally would because the resulting costs can be shiffed onto the other party
Asymmetric information: One of the parties have more information about the product than the other leading to market inefficiency
Measures
Measures
eg. a shop owner not preventing a fire from happening due to insurance
eg. for health insurance, consumers with higher risks buy insurance while firms have to raise prices to cover their losses -> firms refuse to sell to unhealthy people
Investing in information
Signals
Screening
eg. car warranty signals the car is in good condition
eg. medical exam b4 insurance
eg. hiring a mechanic
Incentives
Law
eg. industry standards
Deductibles (initial amount of money the insured party needs to pay b4 the insurance company pays for the rest)
Reward good track record
Factor immobility
Occupational Immobility
Geographical immobility
Inability of a FOP to shift from one use to another
High cost in moving labour between and within countries
Job skill mismatch of labour
shows unemployment and productive inefficiency (within the PPF curve)