Chapt 5 Market Failure Flashcards
Diff ways the market can fail
Market fails if any of these assumptions are false:
.
- good is not a public good
- There are no externalities
- there is perfect information
- there is perfect mobility of resources
- there is no market dominance
3 Govt intervention approaches
- Market-based policies
- provide incentives or disincentives
______________________ - Moral suasion
- Command & Control policies
Characteristics of a public good
-
Non-rivalry in consumption
- 1 consumers consuming the good, does not deprive others of that good
- 1 unit of the good can be used concurrently by others
Eg: When 1 passer-by has experienced the benefits of street lighting by having the light brighten up their path, it does not reduce the availability of light shining on the next person
______________________ ______________________ -
Non-excludability in consumption
- Suppliers cannot prevent anyone from consuming the good once it is made bc it is difficult or costly
______________________ ______________________ -
Non-reject ability in consumption
- Consumers cannot refuse consumption of the good once it is made
Eg: Pedestrians are forced to experience the benefit of street lighting
Diff between public & private goods
- Public: Non- marketable
Private: marketable - Public: Private firms can’t undertake production of the good
Private: Private firms can undertake production of the good
______________________ ______________________ - Public: price mechanism not an allocative mechanism
Private: price mechanism is an allocative mechanism
Why do public goods leads to market failure?
Non-rivalry in consumption
- implies that 1 unit of a good can be used by many people
- there is no marginal cost of producing another unit of a good
- BUT producers are profit motivated
- No effective supply
______________________ ______________________
-
Non-excludability in consumption
- Since consumers cannot reject experiencing the benefits of public goods,
- Since all consumers will benefit,q there is no incentive for ppl to pay for the good
- Free rider problem arises when consumers know it is costly for firms to exclude ppl from having the benefits of street lighting
- so consumers get a free ride by allowing others to pay for the good that they will consume
- no one will actually be willing to pay for the good so there is no effective demand for that good
______________________ ______________________
- When no effective supply or demand, good is non-marketable
- No firms would want to undertake production of that good
- Non-provision of public goods leads to market failure
2 types of Govt intervention in market failure
- Public Goods are supplied by the Govt and are free to the public
Eg: National defence
______________________ ______________________ - Public goods are demanded by the govt on behalf of the general public
- production of pub goods financed by the govt’s budget and it is paid to enterprises
Eg: street lighting
Axises of a market graph
Y axis: ALWAYS Cost/benefit
.
X-axis Quantity of product consumed (for consumers) / produced (for producers)
Define Marginal private cost
Marginal private cost (MPC) is the change in total private cost as a result of consuming an additional unit of a good OR producing an additional unit of a good
Define marginal external cost
MEC is the change in total external cost_** when undertaking an additional unit of an econ activity
Define marginal social cost
MSC is the change in total social cost when undertaking an additional unit of a good
When does Market failure occur
Market failure occurs when the workings of the free market result in inefficient allocation of resources
Advantages and disadvantages of govt intervention for public goods
Adv
- Since govt is producing good to paying firms to produce goods, goods will be produced to maximise Net Social Benefit
_______________________________
Disadvantage
- govt must alr have funds to implement policy
- since govt does not have the aim of maximising profits, they will not undertake the lost cost of production so very expensive
Define negative externality
A neg. Externality is an external cost upon a 3rd party that is not directly involved in consumption/production of a good.
- This 3rd party if not compensated and is made worse off
Define positive externality
A positive Externality is an external benefit upon a 3rd party that is not directly involved in consumption/production of a good.
- This 3rd party can enjoy benefits w/o paying and is made better off
Steps to analysis neg externality usign paper production as eg
using sch and zenith notes
3 step CA + 5 step GA
1. Identify agent of market failure, aims, & MPB and MPC of production
- WHO: In the market for (the good), the agent responsible for market failure is (paper producers)
.
-AIM: Being, a rational decision maker, and in the pursuit of self-interest to maximise (utility/profits), (consumers/producers) only consider their marginal private cost (MPC) and marginal private benefits (MPB) when deciding how much to (consume/produce)
DEFINE MPB, MPC & net PB:
- MPB is the additional revenue generated from sale of paper
- MPC is the additional cost of raw materials, machinery, labour cost, etc
- Net private benefit is maximised when MPB=MPC of (consuming/producing) the good
_______________________________
-
Identify 3rd party & MEC
WHO
- However, the agent does not consider (MEC) to fishermen and ppl living along the river.
_MEC not accounted for _
- Paper producers pollute rivers when producing paper
- Fishermen depend on the river for their livelihood so they have costs when stocks of fish in rivers die from pollution
- Cost from ppl living there: clean up costs, health costs, medical expenses
.
- These are external costs that producers impose on the 3rd party, w/o compensation
_______________________________
3. Identify MSB and MSC
MSC: MEC + MPC
MSB = MPB, Assume MEC=0
__________________________________________
GRAPH HERE 5 step GA
-
Identify agent’s rational output
- Qp is where MPB=MPC
- (Con’s utility/prod’s profits) maximised
_________________________________________ -
Identify socially opt output
- Qs is where MSB=MSC - Since Qp>Qs, over allocation/production
- DWL pointing to to Qs, enclosed by MSB & MSC
- DWL height is length of MEC - LINK
- Society’s welfare not maximised, allocatively ineffcient, market fails
Summary Govt intervention to neg externalities from production
- Market based policies like taxes and subsidies
- Command and control policies like quota, banning, pollution permits, nationalisation
Govt taxing firms for neg production externalities
Method, answer Qn, limitations using ERUPTS, Eval: extent of limitation
