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Flashcards in Week 4- Market Failure Deck (40):

Demand curve = the marginal willingness to pay OR...

marginal private benefit (MPB) if consumption


Maringal social benefit (MSB)

- the benefit of all society gets from consumption of a good



other benefits not accounted for by private consumers of the good


MSB of street trees

- shade, noise reduction, carbon sequestration, aesthetic.
- far outweighs MPB (as home owner needs to buy and care for the tree and likely can't be bothered.



other costs not accounted for by producers


Marginal private cost (MPC)

firm's supply curve


Draw: land clearing example

- MSC curve is higher than MPC curve
- if left to their own devices, farmers would clear Q1 hectares of vegetation (MPC intersect)
- but to consider higher social costs, farmers would need to reduce amount of land cleared (MSC intersect Q*)
- Deadweight loss associated with over clearing as it costs society more than the benefits of more beef production


Market Faulure occurs when...

- the market does not allocate resources efficiently
- When MPB ≠ MSB
or MPC ≠ MSC
- Fre market will allocate resource such that the quantity of final output does not lead to maximum benefit for society.


6 categories of market failure

1. imperfect competition
2. imperfect information
3. inappropriate government intervention
4.absence of clearly defined and enforceable property rights
5. public goods
6. externalities (benefits and costs incurred external to the market - street trees and land clearing examples)


Draw: Deadweight loss with imperfect competition

- competitive industry quantity: were MSB inelastic demand meets MPC/MSC (supply)
- monopolist industry quantity: where supply meets MR
-monopolist: less quantity sold at greater price.
-deadweight loss between the two prices


imperfect competition e.g

- oligopolies in oil
-BeBeers, South African diamond company
- USA pharmical industry: make new drug: patent for 20 years, no one else can sell so seller sells at monopoly prices


imperfect information e.g

- High risk occupation where workers do not have complete information about risks
- Hazards of using chemicals in your home without knowing dangers ad potential side effects
-Farmers are not aware of more financially and ecologically sustainable farming practices (e.g silvopastoral systems vs clearing for grazing)


silvicultural pastural systems

medium density trees on grazing land for:
-shade and shelter (better protected cattle)
-upwelling of nutrients to surface
- greater water content on surface
- when drought comes and cows die, sells trees


Draw: Inappropriate government action of logging on crown logging.

- MPC curve of logging on crown land is lower than MSC curve.
- because social cost is the maintenance of forest, bush fire suppression, construction of roads in the form of taxpayers money.
- logging companies don't pay for ^
- Low crown stumpage prices put downward pressure on what landholders can earn form their private native forests.
- Reduces incentives to maintain tree cover
- Increases incentives to clear for grazing.


Absence of Clearly Defined and enforceable property rights e.g

-global fisheries
- if a group laboured over many conservation efforts, but it is open access, their conservation efforts are useless as there are no restriction on harvesting.


Characteristics of strong property rights

- Clearly defined in their physical extent (e.g in 3 dimension: surface, below, and above)
- Comprehensive (e.g if farmers had full rights to all resources (pasture, water, trees) then more incentive to conserve resources because they benefit from it)
- Exclusive and enforceable
- Long Duration (e.g if 20 years, no incentive to properly manage tree plantation than if it was 40 years)
- Transferable (right to be able to sell your property to someone else e.g native title rights are non transferable
- Divisible (land more valuable if divided)
- Clear and enforced responsibilities


Two characteristics of open access:

1. in the presence of sufficient demand, unrestricted access will cause open access resources to be overexploited
2. as long as profits can be earned people will exploit the resource. Exploitation continues until profits are driven to zero


Draw: North American buffalo e.g

bottom panel:
- x axis quantity of hunting effort (e.g per hour of hunting)
- y axis MRC (assume constant e.g amount of bullets) and also equals ARC
- MRP: declining returns to hunting effort because additional unit of bison declines per unit of time
-net benefits till q*

top panel:
- horizontal fixed cost line (horses, wagon, rifle) irrespective of how many bison are shot.
- total cost curve originating from the beginning of fixed cost line
- total cost: fixed cost + marginal resource cost
-MRC: for each additional unit of hunting effort, MRC goes up by $10 so... hunting effort x 10
- Total revenue is curved (starting from 0)
- Q* is where distance between total cost and total revenue is maximised
- after that is where the accumulated revenue decreases as it is costing more to harvest
- If farmer given exclusive property rights, then bison wouldn't be over harvested, and bison can be given a chance to breed for next harvest



total revenue(MRP accumulated) / labor effort


Well-defined and enforced property rights....

provide a powerful incentive to utilise resources efficiently


Poorly defined property rights that don't enable particular individuals to enjoy. the attributes of an asset leads to...

inefficient exploitation


horizontal aggregate of individual demand curves is for ____ good



vertical aggregate of individual demand curves is for ____ good



markets are most unlikely to arise from public goods as...

- each consumer has different willingness to pay and may not reveal this.


free-rider problem

- market failure exists for public goos because firms cannot capture all of the private benefit enjoyed by consumers (e.g air purification devices require a certain number of subscribers to finance, each consumer realises they're able to free-ride on the contributions of others)
- diminishes the incentive for individuals to contribute to pay for the public good


a free market for public goods will tend to produce ___ than the socially optimal level.



Prisoner's dilemma demonstrates: (2 points)

-why two people might not cooperate even if it is in both their best interests to do so
- Acting in self-interest foes not not necessarily lead to optimal outcomes for yourself


Prisoner's dilemma can achieve optimal outcome if

- each party had altruistic motives and trusted each other


because society can't achieve optimal outcome of prisoner's dilemma (due to acting in own self interest) _____ intervention is necessary

gov (e.g road rules)


prisoner's dilemma for tyre manufactures producing the same types of tyre, with option of investing in clean technology

- consumers are more concerned about price
- firm 1 that produces clean tyres will loose customers that buy cheaper dirty tyre from firm 2
- (2x2 table)


Prisoner's dilemma resulting in climate change

- each country prefers that we prevent climate change, but if country A cuts emissions, country B may gain market share by not cutting emissions (has lower costs)
- neither country cuts emissions, resulting in climate change


Externalities: draw carbon sequestration e.g

- x axis is area of timber plantations established per annum
- MSB higher than MPB
- net benefit that society misses out by not planting the optimum number of trees (deadweight loss) because MPB does not equal MSB.



-positive or negative side effects of a particular activity, which are not internalised by the person or firm undertaking the activity


negative externality change which curve?

MSC curve shifts up to left


positive externality e.g

-street trees: shade, noise, aesthetic
-carbon sequestration of plantation


negative externality e.g

land clearing
-unaccounted for social costs: biodiversity loss, reduced water quality because less vegetation on landscape

-second hand smoke + tax payers money to smokers


positive externality change which curve?

MSB shifts up to right


solutions for market failure from positive externalities

- markets for missed social benefits e.g carbon sequestration market so farmers producer to MSB curve
- directly subsidise cost of production for additional productions


profit maximizing level of output

intersection of marginal revenue and marginal cost curves


In supply and demand framework, market failure refers to a market equilibrium where

Marginal social benefits are not equal to marginal social costs