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Other sources of market failure could include imperfect knowledge and/ or equity
• Define imperfect knowledge
• Explain the causes of imperfect knowledge which leads to market failure
• Explain equity
Part (b): Discussion of the various policies to tackle the problem of externality
Negative externality
• Taxation (explain using a diagram)
• Legislation
• Moral suasion
• Tradable permits (for pollution)
• Nationalisation
Positive externality
• Grants (explain using a diagram)
• Subsidies (explain using a diagram)
• Legislation
• Moral suasion
Sweet are the uses of adversity, which like the toad, ugly and venomous, wears yet a precious jewel in his
head.
Revision Notes for Market Failure
• Difficult to estimate the level of external benefits level of subsidies/ grants may not be adequate
too high a grant/ subsidy may lead to substantial wastage
• Government may need to impose higher taxes to finance the spending adverse effects on the
economy
• For legislation to be effective, there must be some form of monitoring and the costs involved
should be kept low for the implementation
• For moral suasion, the effectiveness of persuasion is not certain since it is voluntary
Negative Externality
• Difficult to estimate the amount of tax + there is administrative costs incurred in collecting the
taxes
• For tradable permits provides incentives to create and use less polluting technologies + difficult
for government to determine the optimal quantity of pollution
• For legislation, cost of intervention may be high because of the administrative costs incurred in
monitoring and enforcing compliance with the legislation
• Legislation does not provide incentives for firms to further reduce their external costs
• Government may create inefficiencies when they intervene through direct production as it may not
produce the efficient level of output even with nationalization. Besides, the government may not
have adequate resources
• For moral suasion, the effectiveness of persuasion is not certain since it is voluntary
Type (B): Market dominance (usually comes in the form of a market structure question)
• In the absence of externality allocative efficiency is achieved when P=MC
• For Monopoly, monopolistic competition and oligopoly, when MR=MC, at the Qe, P>MC under-
allocation of resources allocative efficiency is not achieved market fails
• Ways to correct this form of market failure price regulations/ legislations/ etc.
Sweet are the uses of adversity, which like the toad, ugly and venomous, wears yet a precious jewel in his
head.