How to Evaluate Market Failure

Category: Education

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How to Evaluate Market Failure:

How to Evaluate Market Failure


You will be given a type of market failure and may be asked to evaluate policies When you are asked to evaluate policies you are being asked to make a judgement as to whether it is good or not We use the EEES structure to evaluate market failure policies Effective (Does it work?) Efficient (Does it mean resources are allocated more efficiently) – does the triangle reduce? Equitable – is the policy fair to everyone or does it affect some stakeholders more than others? Sustainable – Does the policy protect resources for future generations EEES


An example Policy – tax on alcohol Effective (Does it work?) Talk about it in theory Show how the tax increases the costs of production for a firm Supply shifts upwards Price goes up Demand contracts But does it contract much? It depends! (good evaluation phrase) It depends on elasticity If the demand is elastic the change will be more than the change in price If the demand is inelastic the change will be less than the change in price If the price changes to P2 and the demand is inelastic the demand will change to Q3 (not much) If the price changes to P2 and the demand is elastic the demand will change to Q2 (more) Effective?


Policy – tax on alcohol Efficient (Does it allocate resources more efficiently or does it reduce the triangle?) If it cause a contraction in demand it is reducing the triangle but by how much? Whether a policy is efficient always depends on how effective it was (did it work) – refer back to the previous slide If it works it will reduce the welfare loss If demand was inelastic it wouldn’t be very efficient and wouldn’t reduce the WL much If demand was elastic it would be more efficient and reduce the WL more Government would need to make the tax quite high to get sufficient change If they tax too much the firm may decide to leave the market causing unemployment Efficient?


Policy – tax on alcohol Equitable? (Is it fair?) Does this policy affect one group of stakeholders more than another The policy will affect low income earners more than high income Low income earners will spend more as a percentage of their income on alcohol than high income This policy will affect those that drink responsibly Is it fair that they are having to pay the price for irresponsible drinkers? Depends! If the issue of irresponsible drinkers is a large enough problem then it is worth doing If the benefits outweigh the costs it is worth doing Equitable?


Policy – tax on alcohol Sustainable (Will this policy help look after resources for future generations) If it works (it is effective) it will help protect resources for future generations Health resources can be put to better use Sustainable?


So is this policy good? Effective – depends on PED but should reduce demand – Yes? Efficient – depends on how effective but will improve WL – Yes to an extent Equitable – not really but does it matter? Sustainable – yes to the extent that the policy works Overall the policy is questionable and perhaps needs another policy alongside it for example education

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