Market Failure

PL2151 PENGANTAR EKONOMIKA

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 Market Failure
 Market failure : a problem that causes the market
economy to deliver an outcome that does not maximize
efficiency
 Market failure occurs in the cases :
1. Monopoly
2. Externalities
3. Public Goods

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 Monopoly
 Monopoly : the only supplier of a unique product with no
close substitutes
 Market power : a firm’s ability to raise the price of a good
without losing all its sales
 Five source of monopoly :
1. Excluisive control over important inputs
2. Patents and copyrights
3. Government licenses or franchises
4. Economies of scale and natural monopolies
5. Network economies

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 PROFIT MAXIMIZATION FOR THE MONOPOLIST

P
S

A
Pm

Pe B

MR D

Qm Qe Q

 Deadweight Loss : ABC

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 Externalities
 Externalities : externalities arise whenever the actions of
one party make another party worse or better off, yet
the first party neither bears the costs nor receives the
benefit of doing so
 External cost : a cost of an activity that falls on people
other than those who pursue the activity
 External benefit : a benefit of an activity received by
people other than those who pursue the activity

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 Negative Externalities

P S=SMC

C S=PMC
A
Pe

Px B

Qe Qx Q

 Deadweight Loss : ABC

 Remedies for negative externalities : tax

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 Positive Externalities

P A S

Psoc B

Ppvt C

Social
Demand
Private
Demand
Qpvt Qsoc Q

 Deadweight Loss : ABC

 Remedies for positive externalities: subsidies

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 Public goods
Characteristics of public goods:
1. Nonrival : One individual’s consumption of a good does
not affect another opportunity to consume the good
2. Nonexlcudable : Individuals cannot deny each other the
opportunity to consume a good

Rival Nonrival
Excludable Private goods Impure public goods
(ice cream) (cable tv)
Nonexcludable Impure public goods Pure Public goods
(sidewalk) (national defense)

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 Public Goods
 Free Rider : One who receives the benefit but doesn’t
bear the cost
 Free rider problem : when an investment has a personal
cost but a common benefit, individuals will underinvest

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 Optimal Provision of Public Goods
P

2 DA

8 Q

3
DB

8
S

P*=5

DAB

Q*=8 Q

 Vertical summation in public goods demand

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 Redistribution
1. End result equity
 Horizontal equity
 Vertical equity

2. Process equity
 Equality of opportunity: the principle that society should
ensure that all individuals have equal opportunities for succes
but not focus on the outcomes of choices made
 Commodity egalitarianism: the principle that society should
ensure that individuals meet a set of basic needs, but that
beyond that point income redistribution is irrelevant

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Methods of Income Redistribution
 Welfare payments and in-kind transfer
 Means-tested benefit program
 Negative income tax
 Minimum wages
 The earned income tax credit
 Public employment for the poor
 Combination of methods

 Equity-efficiency trade-off : the choice society must make

between the total size of the economic pie and its distribution
among individuals

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