Market Failure

Market failure is a situation in which the free market does not operate at
maximum efficiency, meaning the allocation of goods and services is inefficient
within the free market. It also refers to how there exists another possible
outcome where an area of the market or a specific individual may be better off
with a greater allocation of resources without reducing the benefit provided to
another area or another individual. This is considered a market failure as the
market could be more efficient.
Externalities are either a cost or benefit (negative or positive) that affects an
unrelated third party. A positive externality of consumption is the positive effect
an activity imposes on an unrelated third party specific to the consumption of a
good or service. In the case of this report the market I am investigating is that of
vaccinations which provide a tangible benefit to society as a whole, causing a
positive externality. When a positive externality exists in an unregulated market,
consumers pay a lower price and consume less quantity than the socially
efficient outcome.

Market Failure
Vaccines provide a tangible benefit to society. Vaccines provide immunisation
from various forms of harmful diseases such as measles, hepatitis b, meningitis
and many others. This immunisation not only provides individual protection from
that specific disease, but also provides a greater net social benefit in that if
sufficient people within a population are vaccinated, the spread of the disease
can be slowed or halted completely as was the case with smallpox. This helps to
protect vulnerable groups within society, such as the elderly, infants and those
with impaired immune systems. This wide scale population protection, also
referred to as herd immunity, is possible only due too high immunisation rates.
Along with this immunisation, there have been numerous studies and reports
from around the world including the NZ Ministry of Health that show additional
societal benefits related to vaccinations. One of the main additional benefits is
that of increased general health of vaccinated groups, one study citing
vaccinated childrens test scores to show they have a generally higher mark,
likely due to healthier children more frequently attending school and as such

learning more. This general trend of better health has far reaching
consequences, having positive effects on areas such as productivity, education
and investment. The profound that vaccinations have in New Zealand and
around the world is summed up best by the statement The impact of
vaccination on the health of the worlds peoples is hard to exaggerate. With the
exception of safe water, no other modality, not even antibiotics, has had such a
major effect on mortality reduction and population growth source 5

This graph (source: http://www.stats.govt.nz ) shows the percentage of children

in New Zealand immunised against various diseases compared to the rest of the
world as of 2013. As is clear from the graph, New Zealand has a high level of
immunisation coverage when compared, and this is reflected when compared
with information regarding the spread of various diseases within New Zealand.
An example of such being pneumococcal disease mention in an immune.org
article (source 1). Since the introduction of the pneumococcal vaccine in New
Zealand in 2008, the rate of this disease in children under two years old has
halved (from just over 96 cases per 100,000 to 46.4 cases per 100,000).
The Market Failure related to vaccination occurs in the form of a positive
externality of consumption. Vaccination provides clear benefit for the whole of
New Zealand society, but for this benefit to be fully realised more resources need
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Market Failure
to be allocated towards vaccination proliferation, something the New Zealand
government is in fact trying to do, with an eventual immunisation target of 95%
(source 2).

Price
Graph showing positive
externality of consumption
market failure for
Vaccinations. (Graph 1)

P1
P
SMB
MB
Q

Q1

Quantity

This graph represents the market failure for vaccinations, a positive externality of
consumption. The label P on this graph shows the price at which free market
equilibrium occurs. P1 represents the price at which optimum efficiency can be
achieved. Q is the quantity where market equilibrium is achieved (free market
allocation), whereas Q1 is the quantity representing optimum efficiency (socially
optimum allocation). Therefore P x Q shows us the market equilibrium and P 1 x
Q1 shows market efficiency. This graph shows us that optimum efficiency has not
been achieved, as this would require a greater allocation of resources from within
the free market situation, providing a greater benefit to New Zealand society. The
graph makes it clear (difference between P x Q and P 1 x Q1) that for optimum
efficiency to be reached and increase in price and quantity would have to occur
from the greater allocation of resources.
One effective policy that the government could introduce to help achieve
optimum efficiency within the free market is the Marketing/ad Campaign, also
known as a Government endorsement.
This government endorsement would take form as a nationwide marketing
campaign, aimed at promoting vaccinations throughout the country. Within the
context of this report an example of such a campaign would be both a
nationwide television advertisement highlighting the benefits of immunisation
through vaccination as well as mentioning the wider benefits, the ease of access
to vaccines country wide and the way in which this benefits the individual. The
idea behind such a campaign would be to increase the number of individuals
getting vaccinated so as to increase the percentage of the population nationwide
that is vaccinated, providing herd immunity, as well as benefitting New Zealand
society as a whole through the increased health benefits and the flow on effects
from such. Such a campaign would come about as the positive externality of
consumption market failure of the free market for vaccinations can be solved
through an increase in Demand. As demand increases a greater number of
consumers would be more willing to pay a higher price to receive the
service/good of vaccination. This increase in demand would create market forces
in the form of shortages, causing the price of vaccinations to rise, as this price
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Market Failure
rises, individual consumers would be less willing and able to purchase
vaccinations, and as such market equilibrium will be re-established at the new
higher price

Price
MC/ S
P1
P
SMB/ D1

Positive externality of
consumption Graph showing
increase in demand for
Vaccinations due to effect of
Government advertising
(Graph 2)

MB/ D
Q

Q1

Quantity

The increase in demand that this graph represents is shown through the increase
from D to D1, thus changing the equilibrium from P and Q to P 1 and Q1 meaning
the new market equilibrium is P1 x Q1.
This policy is attractive to the government as it requires no direct interference in
the free market by the Government, instead using already existing market forces
as well as an external factor (the ads) to improve the efficiency of the free
market.
Another policy that would be effective in altering the market failure of
vaccinations would be that of a Government subsidy. Such a subsidy would lower
the price consumers would have to pay for the vaccinations, therefore increasing
the quantity that consumers are willing and able to purchase as they are now
more affordable. Vaccine producers are willing to provide enough so that there is
no shortage as the government covers the difference between the price required
for them to be willing and able to bring sufficient quantity to market that equals
what consumers demand and the price consumers actually pay. Subsidies are a
common method governments use to keep the price of a certain good or service
low so as to be affordable to the majority of consumers, a prominent example of
such within New Zealand is that of the governments childcare subsidy.
By subsidising the vaccination market more resources can be allocated from
within the free market to the area without having a negative effect on consumer
demand. Meaning producers are willing to supply increased quantity at a lower
price. Meaning more individuals will seek vaccinations as they are now relatively
more affordable.
The primary downside of such a policy would be the monetary cost of maintain
the subsidy over any significant length of time (more of this within the efficiency
and equity section of report)

Market Failure

Price

P1
P

Positive externality of
consumption Graph showing
effect of a Government
subsidy on free market for
Vaccinations
(graph 3)

P2

P represents the
starting price at
which current market
equilibrium rests, P1
represents the new

SMB
MB
Q

Q1

Quantity

price that producers receive for each unit consumed. Whereas P 2 is the new price
the consumers pay for each unit consumed (the difference being the value of the
subsidy). Q1 is the quantity both demanded by consumers and supplied by
producers. The government pays the difference in price between P 2 and P1 to
producers. So consumers pay P2 x Q1, the producers receive P2 x Q1 and the
government pays (P1 P2) x Q1 to the producers. Ultimately this policy will result
in the ability to allocate more resources to different areas of free market,
improving efficiency.
Efficiency of Policy Subsidy
The efficiency of a given policy is shown in how well it corrects the market failure
of the free market. Within a normal free market situation instituting a subsidy
would make the market less efficient due to the factor of dead weight loss. Dead
weight loss refers to the loss of allocative efficiency encountered in a market
when an external force (such as a government subsidy) acts within the free
market. However outside of a normal free market situation, specifically within
this context the effect of dead weight loss is countered by the benefit to society
(marginal social benefit) brought about by the use of a government subsidy. With
reference to graph 2, demonstrating the effect of a subsidy, it is clearly shown
that the new quantity of Q1 and the new producer price, P1, are equal to the
optimum quantity and price shown in graph 1, Graph showing positive
externality of consumption market failure for Vaccinations. This means that the
vaccination producers receive resources equal to the optimum price and are
therefore supplying optimum quantity to consumers (P 1 x Q1). From this it can be
concluded that a subsidy can restore the free market situation from market
failure to optimum efficiency.
Equity of Policy Subsidy
Equity in relation to economics is any situation or outcome that could be
considered fair and unbiased. In the context of this report and relating to the two
policies Ive selected, the equity of each policy is based upon the relative
advantage (benefit) or disadvantage as well as fairness, received by all parties
involved. Judging the equity of a government subsidy, such as this policy, is
difficult in that it benefits all parties in some way, but not equally, and as such
deciding the overall equity of the policy is challenging
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Market Failure
With the policy of a subsidy the government is in effect paying the difference
between the price the consumer pays (P 2) and the price that the producer
receives (P1). This clearly makes it more profitable for the producer, and as such
they are more willing and able to supply more. This extra supply is in turn
purchased by the consumer as they are now paying a lower price (P decreased to
P2 graph 3) so they are also more willing and able to buy more. In the context of
the free market for vaccines, producers have the economic incentive of the
subsidy to produce a greater quantity of vaccines and consumers are enticed by
the lowered price and other inherent benefits of the vaccine itself.
Another aspect of this policy is the funds necessary to support the cost of the
policy. These funds come from the various taxes and other revenue sources
utilised by the New Zealand government, such as GST, Income tax, residential
tax, along with a number of tariffs on trade goods etc. Among these however the
main one is that of income tax, as the name suggests this tax is based on an
individuals yearly income, those with a higher income pay comparatively more
as they can afford to contribute more to support society. As the main funding of
this policy comes from the taxes paid by all individuals within New Zealand, even
those who dont vaccinate or who those who already have, this policy could at
first glance be considered iniquitous as it appears to take resources from all but
gives back to relatively few, people bearing the cost for a subsidy that seemingly
has no effect on them. However it is my view that the wider societal benefits that
are provided by vaccinations, such as the herd immunity mentioned earlier and
other related advantages, provide a greater overall value, outweighing the
possible inequity, as these people not directly affected will be effected by the
benefits such as those of greater population immunity/resistance to diseases.
A further factor to be considered in regards to this policy is the substantial
ongoing cost when compared to the other policy in this report, the exact cost is
dependent upon how much the government has to subsidise to achieve free
market efficiency. As such this policy is an ongoing drain on government
resources, although likely not as significant as other subsidies in place in other
areas. This ongoing cost however would be shouldered by the taxpayer and as all
taxpayers would be positively affected to some degree this is a cost that can be
considered fair and equitable.
Efficiency of Policy Government Advertisement
Campaign/Endorsement/Marketing

Market Failure
In theory this policy has the potential to achieve optimum efficiency within the
free market situation. However in practice the true effectiveness of this policy is
hard to evaluate as actually measuring and accurately predicting the impact the
policy will have on demand would require much additional research into factors
outside this report. However there are generally two to three effects this policy
Increase in Demand for
Vaccinations Minimal
Increase (graph 4)

Increase in Demand for

Vaccinations Extreme Increase
(graph 5)

Price
MC/ S

Price

MC/ S

P2
P1

P1
P2
P

SMB

Q1
Q2

D1

D1
MB/ D
Quantity

SMB
Q

Q1 Q2

MB/ D
Quantity

could induce in the market situation. The first is shown in graph 2, a Positive
externality of consumption graph showing increase in demand for Vaccinations
due to effect of Government advertising. This graph is the best possible outcome
for this particular policy, achieving optimum efficiency at P 1 and Q1 meaning
effective allocation resources throughout the free market as well as optimised
social marginal benefit. However because of the unreliability inherent in this
policy due to the uncertain nature of humanity, this exact outcome is unlikely to
completely occur, rather a variation of the two graphs above.
If the demand curve (D) does not increase enough due to government
advertisement, then optimum efficiency is not achieved and the full social
marginal benefit is not reached (graph 4). The new demand curve (D 1) is below
the SMB curve (which represents optimum social benefit), meaning that both the
new price and quantity (P1 and Q1) are not reached.
On the other end of this scale is if the demand curve were to increase too far and
surpass optimum efficiency, meaning the benefit achieved is no longer worth the
resources put into acquiring it (graph 5).
Because of this lack of a truly reliable outcome in regards to the efficiency of this
policy, I have concerns as to whether it is in fact a viable policy in relation to this
report. If the demand is increased sufficiently to reach optimum free market
efficiency then this is a very efficient policy, the problem is that such an outcome
is uncertain and if that outcome isnt achieved then there is wasted resources
and still an inefficient free market situation, as the original market failure, a
positive externality of consumption is still in effect. The opposite of this is if the
demand becomes greater than the social marginal benefit curve (SMB), then the
market becomes a negative externality of consumption. Meaning more resources
are used in this area than the benefit is worth. Given the uncertainty and

Market Failure
unpredictability surrounding the possible outcomes of this policy I am weary of
recommending this course of action based solely on the efficiency
Equity of Policy - Government Advertisement
Campaign/Endorsement/Marketing
Compared to those of the subsidy the costs involved in this policy are very small.
As such in the area of cost/benefit when related to equity, this policy trumps that
of the subsidy in that the cost the taxpayers have to shoulder is much smaller.
This smaller cost is due to the differing resource needs of these two policy.
Setting up the advertisements (filming, actor pay, set cost, visual design etc.), is
a relatively small one off cost, after which the Government can run the
advertisement campaign at minimal cost, just paying for the running of
advertisements etc. This cost shouldered by the tax payers is balanced by the
net social benefit provided by the vaccinations. However the problem with this
policy is that the outcome of such an ad campaign is only partially predictable,
with the three options related to achieving the optimum efficiency of the market
being the most likely outcomes, two of which only provide some benefit,
meaning that the taxpayer could be paying for a useless policy. A final factor
important to this policy is the problem that it is a physical policy, it doesnt
change legislation, offer incentives or such. This policy instead relies upon
consumers reactions to the adverts, whether they be interest or ignorance, to
entice them to a vaccination. This method, of using television and online
advertisements would likely work for most people, but of the many people who
dont vaccinate there are the poorer individuals and families, such people may
not have access to the internet or a television with which to see the
advertisements. Contrary to this the subsidy provides cheaper vaccines, no
matter where or from what background you hale.

Comparison Subsidy and Ad Campaign

When comparing and contrasting these two distinct policies the primary factors
to take into account are those of Efficiency and Equity. With the final question
being which of the two policies offers a greater balance of efficiency and equity
when compared to their various individual costs and benefits. One of the first
major things of note is the contrasting costs associated with each policy. The cost
of the subsidy is dependent upon how much the government has to subsidise to
achieve the desired market effect of optimum efficiency and how long they must
keep subsidising to maintain this affect. Such a thing represents a significant
yearly cost. This contrasts heavily with policy of a government ad campaign
which has a comparatively small cost of setting up the actual ads and then
keeping them running so as to promote the ideas expressed. Both policies are
similar in that they have the potential to achieve the desired objective, optimum
market efficiency. However the manner and the reliability with which this
objective is achieved is very different between the policies.
The subsidy policy works by having the government effectively pay a portion of
the cost of the vaccines directly to the producer so that the consumer can buy at
a cheaper price (Graph 3, P1, P, and P3). This is a direct method of approach,
8

Market Failure
utilizing internal market forces, such as shortages and others to increase the
demand and supply so as to reach optimum market efficiency, whilst shouldering
negative market forces such as dead weight loss. Another key part of this
strategy is that of the economic and healthcare incentive, due to the cheaper
price of vaccinations, people are more willing and able to get them as it effects
their wallet less and makes them healthier overall, making it markedly more
efficient. On the other hand the Ad campaign policy takes a more subtle,
external approach utilizing already extant market forces. This policy instead of
directly forcing the market into actions, seeks to influence the consumers
directly. By provide factual and interesting information in regards to the
vaccination available the advert would seek to encourage audiences to go to the
various vaccination centres. A passive approach compared to the active one of
the subsidy policy.
This leads on to another key difference in the policies methods, the subsidy is
itself not contained in the physical medium, it is instead more of a policy change
then a bank draft of sorts from the government to the various producers. This
incorporeal state and wide ranging beneficial effects means that the subsidy
effects anyone involved with vaccinations, anyone who wants to buy, one it is
now cheaper. This contrasts with the physical method of the ad campaign
policy. Which seeks to utilise television and online adverts to inform people of the
vaccinations. This contrast is odd in that it highlights the dichotomy of the two
policies, the subsidy policy is subtle in regards to its real world noticeability,
whilst being extremely unsubtle in a market situation, effectively forcing the
price down. This is the opposite of the ad campaign policy which is subtle in the
way it effects the market model and unsubtle in interaction with the consumer,
who must deal with the ads.
This leads back to the overall costs of the differing policies versus their equity
and efficiency. Whilst the ad campaign policy can be consider to be more
equitable in that it is less of a drain on resources, this is offset in the way in
which it is unreliable, it is hard to measure the effectiveness of such a policy,
relying on the response of the consumers who view the advertisement. As well as
the possible failure of the policy overall (graphs 4 and 5) where it could under
shoot or overshoot the goal of optimum efficiency by a wide margin. The subsidy
on the other hand costs much more, and will continue to be a drain on resources
over time, however the benefit of this is that it provides a tangible benefit to
everyone involved straight away, the economic incentive of the cheaper vaccine.

Recommendation
My recommendation on which policy to adopt overall is that of the subsidy, whilst
it has its draw back as with any policy, it is my belief that the societal benefits of
such a policy outweigh the negatives.
This policy provides a reliable way with which to alter the behaviour of the free
market, a reliable way with which to achieve the objective of optimum market
efficiency. This policy of a subsidy is not only overall more efficient it is also in my
view more equitable as a whole. The efficiency of this policy is evidenced in the
graph (graph 3) where we can clearly see that such a policy leads to the desired
objective
9

Market Failure
The government pays the difference in price between P 2 and P1 to producers. So
consumers pay P2 x Q1, the producers receive P2 x Q1 and the government pays
(P1 P2) x Q1 to the producers.
Along with this is perhaps the most negative of the factors related to this policy,
the large cost in relation to the ad campaign policy. When compared these
policies had very different cost levels, with the subsidy having a much higher
cost, so perhaps the ad campaign was the more fair policy in regards to all
stakeholders involved? It is my view however that this is not the case, the main
example being graphs 4 and 5, representing the likely possible outcomes of the
ad campaign policy, these two graphs show either the outcome in which the
objective is undershot or it is instead overshot, producing a negative gain. Along
with this however is the way in which the dead weight loss as an example,
cancels out. As mention earlier the Dead weight loss refers to the loss of
allocative efficiency encountered in a market when an external force (such as a
government subsidy) acts within the free market. However outside of a normal
free market situation, specifically within this context the effect of dead weight
loss is countered by the benefit to society (marginal social benefit) brought about
by the use of a government subsidy. These benefits are as stated earlier,
numerous, but among their number include general health benefits that have
flow on effects impacting areas such as productivity, education and investment.
It is my recommendation that the policy of a subsidy be used instead of that of a
government lead ad campaign because it is my belief that subsidy model offers a
superior level of social benefits, such as the decreased cost in vaccines, despite
the cost when compared to the alternatives, the social marginal benefits
outweigh the negatives of such a plan, as such I believe it to be the best option
of the two policies.

Source 1
http://www.immune.org.nz/sites/default/files/resources/MoH__targeting_immunisa
tion_increasing_immunisation__20110301.pdf
Source 2

10

Market Failure
http://www.health.govt.nz/new-zealand-health-system/health-targets/abouthealth-targets/health-targets-increased-immunisation
Source 3
http://www.stats.govt.nz/browse_for_stats/snapshots-of-nz/nz-socialindicators/Home/Health/childhood-immunisation.aspx
Source 4
http://www.immune.org.nz/sites/default/files/resources/ConcernCritiqueFussIAS20
1011V02Final.pdf
Source 5
http://phaelosopher.com/2012/08/06/vaccinations-time-to-speak-theunspeakable/

11

Market Failure

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