Market failure: exists whenever the free

market equlibrium quantity of output is

freat or less than the socially optimal
level of output. The free market will
produce too much or too little of a good.
-More (or less) is sold at a lower (or
higher) price than is socially desirable.
Types of market failure:
-negative/positive externalities
-lack of public goods
-common access to resources and threat
to sustainability
-asymmetirc information
-abuse of monopoly power.
Externality - when the actions of
consumers or producers give rise to
negative or positive side-effects on
other people who are not part of these
actions, and whose interests are not
taken into consideration.
-All negative externalities create external
are external costs, MSC
costs. When there
> MSB at the point of production by the
market.
-All positive externalities create external
benefits. When there are external benefits
MSB > MSC at the point of production by
the market.
-All production externalities create a
divergence between private and social
costs (MPC and MSC).
-All consumption externalities (positive and
negative) create a divergence between
private and social benefits (MPB and MSB).

Negative production externalities - making of a

product creates spillover costs to others MSC > MPC
(i.e. air poillutions, workers health)
Solutions:
Tax shift MPC left,
-welfare loss reduced, internalize, output goes down
-magnitude & tax hard to assess, cannot deter, only
reduce.
Legislation & regulation
-laws costly to implement, government resources
costs, legal expenses.
-extreme ban good.

Positive production externatlities - making of a

product creates spillover benefits to others - MPC>MSC
(i.e. tree farms, workers training, research)
Solutions:
Subsidies
-pay industry, push MPC right,
-money drawn from other areas.
State provision of the article
-directly provide the good
-costly, accurately predict needs.

Negative consumption externalities - use of product

creates spillover costs to others MPB < MSB
(i.e. smoking, alcohol, automobiles)
Solutions:
Legislation & Regulation
-deem activities illegali, limited or restricted
-great bureaucracy required to enforce
Taxation
-interalize make actors involved pay
-shift MPC left, reduce consumption.
Advertising & Persuation
-discourage further use of product, MPB shifts left]
-advertising - expensive

Positive consumption externalities - use of a

product creates spillover benefits to others
(i.e. education)
Solutions:
Subsidies
-make good more affordable, shift MPC right
-opportunity cost of subsidy vs. merit of good
Advertising
-advertise benefits, campaign, shift MPB right
-may be affected by cultural attitudes
Legal requirements
-legally mandate behavior, unlikely complicance
unless publicly procided.
-size of potential benefits

Where there are externalities:

-social benefits = private benefit + external benefit Tragedy of the commons common
-social costs = private cost + external costs.
resources are used and degraded rapidly by
private individuals for short term benefits
Where no externalities exist:
-social benefits = private benefits
(e.g. forests, water sources)
-social costs = private costs
-free rider problem users do not pay market

MPC
- costs to producers of producing one
price and have little incentive to ration it
more unit of a good
MSC - costs to society of producing one more
Fossil fuel consumption:
unit of a good
MPB - benefits to consumers from consuming
-air pollution, acid rain, threaten habitats
one more unit of a good
MSB - benefits to society from consuming one
Poverty in less developed countries:
more unit of a good
-income rise, demand for advanced goods,
Pareto Optimal market situation where no
one can be made better off without making
import trade with rich countries --incomes
someone worse off.
rise slower than rich countries
-sell more primary goods depleteing other
Factor immobility
resources, debt burden
-workers will stay in an area
-land & natural resources fixed
Potential solutions to sustainability
Inequality
problems
-nature of opportunities being exploited
Extension of property rights
-redistrubution of income progressive tax,
-create long term interest in survival
welfare insurance
Carbon taxes
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-internalize externalities
-poorly designed, unforeseen consequences,
Tradable permits
trade votes
-system of taxing pollution levels where
pollution licenses are exchangable bewteen
Short-termism
-rational short term objectives cause long term
firms
problems stock valuations rewards
-total licensed pollution perfectly inelastic
-politicians create policies for elections
-opportunity costs forgone services.

Merit good create positive spillover benefits, under produced

(i.e. religious schools)
-MSB > MSC when sold on open market
-encourage consumption to capture potential welfare gain.
Public good
(i.e. roads, prisons, streetlights)
-non-rivalrous one persons consumption does not prevent
others from enjoying it.
-non-excludible producer cannot precent particular individuals
from enjoying the benefits.
Demerit good negative spillover costs to third parties.
(i.e. drugs, alcohol)
-persuasion, taxation, regulation, ban

CHAPTER 6 MARKET FAILURES