Market Failure Flashcards
market failure arises from public goods because
non-excludable –> impossible or prohibitively expensive to exclude non-payers from consuming the good once it is produced [free-rider problem] –> due to the absence of a price signal, producers will not supply the good –> missing market
non-rivalrous –> consumption of the good by a consumer will not reduce the amount available to other consumers –> marginal cost of provision, i.e. the additional cost resulting from providing a good to one more consumer = 0 –> for AE to be achieved, P should = 0 –> profit-driven firms will only sell the good at a positive price —> no allocative efficient firm in the market
market failure arises from externalities because
externalities –> external costs/benefits that accrue to third parties not involved in the economic transaction
presence of the marginal external cost/benefit (MEC/MEB) creates a divergence between marginal social cost/benefit (MSC/MSB) and marginal private cost/benefit (MPC/MPB) –> MSC/MSB is higher than MPC/MPB by MEC/MEB
a consumer seeking to maximize his own private interests would disregard the external costs/benefits to third parties –> consume till MPB = MPC –> private eqm is at Q where MPB = MPC
however, the socially efficient level of output is actually at Q* given by the intersection between MSB and MSC, where society’s welfare is maximised –> over/under-consumption of QQ* units –> DWL to society as the total social costs of consuming QQ* units is higher/lower than the total social benefits
hence, when left to the free market, over/under-consumption due to externalities occurs, leading to an over/under-allocation of resources and thus market failure
market failure due to information asymmetry
information asymmetry arises when one party in an economic transaction, either the buyer or seller, has more or better information than the other
when both buyers and sellers are perfectly informed about the quality of the goods traded in the market, the prices will adjust to reflect quality differences
with full information, the market is allocatively efficient since the goods go to the people who value them the most
information asymmetry may arise in the form of adverse selection or moral hazard
adverse selection occurs when the party with less information ends up having to choose from an undesirable or adverse selection of goods
moral hazard occurs when the party with more information gets involved in a risky event knowing that it is protected against the risk, and the other party with less information incurring the cost
market failure arises from imperfect information because
if left to free market forces where consumers pursue self-interest to maximize their own welfare, demand is higher/lower at D0 due to the over/under-estimation of their private benefits –> had they possessed accurate information about the benefits accrued, the demand curve would have been much lower/higher at D1
free market equilibrium occurs at Q with imperfect information, but the socially efficient output level is at Q* with perfect information –> over/under-consumption of QQ* units –> DWL to society as the total social costs of consuming QQ* units is higher/lower than the total social benefits
hence, when left to the free market, over/under-consumption due to imperfect information occurs, leading to an over/under-allocation of resources and thus market failure
evaluation of policies to correct information failure
education [imperfect info]
- addresses root cause
- takes time
- ultimately depends on the receptiveness of the public to the info provided
subsidies [imperfect info]
- govt’s imperfect info about the extent of MF –> difficult to place an exact monetary value on MF –> possible govt failure
- doesn’t address the root cause –> if consumers do not realise the true benefits, they are unlikely to respond to subsidies
- strain on govt budget [opp cost]
legislation [imperfect info]
- monitoring and enforcement [costs / feasibility]
Medishield Life [adverse selection]
- compulsory
- UC: moral hazard
copayment + deductibles
- ensure consumers pay at least part of their HC cost –> more incentive to take good care of their health
- UC: inequity [necessities become less affordable]
factors that govts consider when addressing the issue of information failure are
root cause –> diff types of information failure –> exp the policies to show how they address the problem
extent of MF –> if the MF is significant, e.g. vaccination, govt will use legislation to make it compulsory even though it may not address the root cause to ensure a certain outcome in the SR
UC –> policies used may lead to other problems, e.g. copayment + deductibles corrects moral hazard but worsens inequity
budget position –> policies are costly –> strain on govt budget + opp cost
is there a need for the govt to intervene? –> consumers are more educated + information is readily available + markets can sometimes come up with solutions themselves, e.g. insurance market is not “missing”, it pays for consumers medical checkups and charge premiums according to the consumers’ health conditions –> if the govt intervenes when there is no need to, wastage of resources + distortion of price signals –> outcome may not be desirable
a rational consumer’s decision depends on
MPB [downward slowing due to LDMU] –> satisfaction due to consumption of an additional unit of good
MPC –> cost due to consumption of an additional unit of good + opp cost
consume at Q where MPC = MPB
consumers’ decisions may not always max consumer and social welfare because
cw: imperfect information –> MPB (true) vs MPB (perceived)
sw: externalities in consumption
factors that govts consider when addressing the issue of public goods are
benefits
- micro –> AE
- macro –> G↑–> AD↑
costs
- monetary cost
- opp cost
- UC
feasibility
- budget position
others
- extent of intervention –> extent of MF –> since there is complete MF, intervention is sig
- how to intervene –> direct provision since P mechanism fails completely
a govt’s choice of policy to deal with market failure depends on
root cause
- externalities –> subsidies + taxes + legislation
- imperfect information –> education + subsidies + taxes
- asymmetric information –> copayment + deductibles + legislation
- public goods –> direct provision
extent of MF
- does the govt need to intervene? –> consumers are more educated + information is readily available + markets can sometimes come up with solutions themselves, e.g. insurance market is not “missing”, it pays for consumers medical checkups and charge premiums according to the consumers’ health conditions –> if the govt intervenes when there is no need to, wastage of resources + distortion of price signals –> outcome may not be desirable
- if the MF is significant, e.g. vaccination, govt will use legislation to make it compulsory even though it may not address the root cause to ensure a certain outcome in the SR
budget position
UC
- tax –> worsens inequity
the extent of govt failure depends on
whether the govt has imperfect information
whether the govt chooses an appropriate policy [that matches an extent of MF]
whether steps are taken to address the potential UC of policies
factor immobility may be a concern for SG because
FOPs are not responsive to price signals –> when dd rises –> shortage –> upward pressure on P, signalling to producers to allocate more resources –> however, if FOPs are immobile, producers are not able to respond effectively –> under-production –> AEx
FOPs are not fully utilized –> economy is operating inside PPC –> PEx
causes –> geographical [poor transport networks –> difficulty in travel] + occupational [restructuring of economy –> mismatch of skills]
SG –> rapidly restructuring + resource poor –> need to make full use of our limited HR –> implications: SUE + WIG –> harder for SG to achieve IEG
