Types of Market Failure

Market Failure: 

Market Failure Chapter 12

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Learning Objective: To gain a general understanding of the different types of market failure Learning Outcome / Success Criteria Name the different types of market failure Give examples of the different type of market failure

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What do we know about the market so far?

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How could we define the perfect market? A free market that supplies exactly what consumers demand So market failure can be When the free market fails to provide at all When the free market provides too much When the free market provides too little When the free market provides but it has an effect on a third party that is not involved in the production or consumption (that effect can be good or bad) On the next slide I am going to show you some examples of market failure In pairs, I want you to take 10 minutes to Decide what kind of market failure each one is Think about the reasons why the market fails E.g. what would make the market fail to provide?

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So which is number 1? It is a vaccination service It is known as a merit good Merit goods are often services The government thinks that merit goods provide positive benefits for both the people that use them and society as a whole Why in this case? They should be consumed to a greater degree Because the market doesn’t provide enough (because there is not enough demand) the government has to step in How can it supply more? It can provide them directly It can subsidise them so that there is no direct cost to the consumer Why no direct cost? Because they pay indirectly through taxes Merit goods are products that society values and judges that society should have regardless of whether an individual wants them

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Information failure: merit goods Merit goods are products that society values and judges that society should have regardless of whether an individual wants them It is important to remember that to classify a good as a merit good will require society to make a value judgement The UK government believes that individuals may not act in their own best interest in part because they do not have the full information on the long term benefits (information failure) Merit goods are an example of partial market failure – where the free market will lead to the provision of a product but in the wrong quantity leading to a misallocation of resources Government will seek to encourage more consumption of merit goods

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Why is this a merit good? If the government didn’t provide schools would everyone pay for it? Maybe you would be too poor to afford it and leave your kids at home The market would not provide enough so government has to step in

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Why are these Merit Goods? Would government provide or subsidise these services to the same extent? Some will be more important than others and will gain more funding

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So which is number 2 – over/under provided, 3 rd part effects, not provided? It is fast food It is known as a demerit good The government thinks that demerit goods are bad for both the people that use them and society as a whole Why? They should be consumed to a lesser degree Because the market provides too much (there is too much demand) the government decides to step in How can it reduce supply? It could ban them It could educate consumers on the harm Anything else? It could put a tax on them How would that work? Demerit goods are those products that society deems as bad for you - again a value judgement is being made

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Why are these Demerit Goods? If government chose tax to reduce alcohol consumption would it tax the same % as cigarettes? Cigarettes may be seen as more harmful than others and have higher taxation

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So which is number 3? Over/under provided, 3 rd part effects, not provided? It is a factory creating pollution It is known as a negative externality What is the cost imposed on the third party here? The pollution may cause harm to society – the fumes may cause ill health to those that are not involved in the production When the firm decides how much to provide what will it think about? It is a profit maximiser Costs will be the most important thing – if costs are low profit will be high It only thinks about its private costs; not the cost to society Together all the firms in the market provide too much so the government feels the need to step in What could it do to get the market to supply less (and therefore pollute less)? Negative Externality : costs imposed on a third party not involved with the consumption or production of the good

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What can government do to fix externalities? Regulation – government can set restrictions and inspect to see these are being upheld. If not large fines may be levied Pollution permits – essentially using the market to address the problem rather than through regulation. Government issues or sells permits to firms allowing them to pollute to a certain limit This increases their costs But…they can be traded to reduce the cost creates an incentive to be clean because they can sell on remaining allocation. Firms that pollute will have higher costs than those that are clean Regulation is the stick and the pollution permit is the carrot Downside – Both need teams of inspectors Firms may move to countries that do not penalise e.g. India

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Negative externalities Why is this a negative externality? What is the private cost? What is the external cost (the cost to the third party) The social cost is both of these added together In a perfect market the private costs would be the same as the social costs Because the social cost is larger than the private cost there is market failure

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Negative externalities Why is this a negative externality? What is the private cost? What is the external cost (the cost to the third party) The social cost is both of these added together In a perfect market the private costs would equal what? They would equal the social costs Because the social cost is larger than the private cost there is market failure

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Negative externalities Why is this a negative externality? What is the private cost? What is the external cost (the cost to the third party) The social cost is both of these added together In a perfect market the private costs would equal what? They would equal the social costs Because the social cost is larger than (?) there is market failure ? = the private cost

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So which is number 4? Over/under provided, 3 rd part effects, not provided? It is a light house It is known as a public good There is a missing market Why would the market not provide it? Watch this mjmfoodie video (3 mins) http://www.youtube.com/watch?v=mYtW1Ug7L_s&feature=related Public Good : goods that would not be provided by the free market

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Public goods Pure public goods have three main characteristics: Non-excludability: The benefits of public goods cannot be confined to those who have paid for it Non-payers can enjoy the benefits of consumption at no financial cost to them Non-rivalry in consumption: Consumption of a public good by one person does not reduce the availability of a good to others In other words, if the good is provided for one person it must be provided for others Non-rejectable If a public good is provided, we cannot avoid it Why would the ‘market for viewing the sunset’ be a missing market?

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Why are these public goods? Non-excludablity? Non-rivalrous? Non-rejectable?

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Why is this park bench a public good? Non-excludablity? Non-rivalrous? Non-rejectable?

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Could we make it into a private good? Watch this video!! http://vimeo.com/1665301

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The learning outcome bit!! Write down the answers and then swap with the person next to you Market failure can be…… fill in the gaps When the free market fails to? provide at all When the free market provides? too much When the free market provides? too little When the free market provides but it has an effect on a? third party that is not involved in the production or consumption (that effect can be good or bad) A Merit good is…. (give an example) A good that the government believes is good for you e.g. vaccinations A Demerit good is ….. (give an example) A good that the government believes is bad for you e.g. alcohol A Public good is…… (give an example) A good that the government has to provide because the market does not – a missing market e.g. army, police, lighting etc An example of a negative externality is? Pollution, mobile masts, wind turbines etc

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Learning Objective: To gain a general understanding of the different types of market failure Learning Outcome / Success Criteria Name the different types of market failure Give examples of the different type of market failure Did we achieve these?