Market failure
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Market Failure. Content. Externalities in Production and Consumption: Positive Negative Public goods Merit goods Demerit goods Market imperfections Inequalities in: Wealth distribution Income distribution. Externalities.

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Presentation Transcript

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Content

  • Externalities in Production and Consumption:

    • Positive

    • Negative

  • Public goods

  • Merit goods

  • Demerit goods

  • Market imperfections

  • Inequalities in:

    • Wealth distribution

    • Income distribution


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Externalities

  • Externalities result from differences between private and social costs or benefits

  • Externalities can be positive or negative:

    • Positive – these have beneficial effects on 3rd parties

    • Negative – these are costs that incurred by 3rd parties


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External Costs / Negative externalities

  • External costs created by businesses can impact the environment in the following ways:

  • Urban blight – excessive development and inappropriate developments mean the environment is visually less attractive, loss of farmland

  • Production and disposal of waste – this could include an increase in litter and rubbish from packaging

  • Use of energy

  • Pollution:

    • Noise – from cars, lorries, factories etc

    • Air – emissions from cars and delivery vehicles

    • Land

    • Sea

    • Water


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Negative externalities

  • If you consider private costs then they would supply along supply curve S

  • Negative externalities mean that social costs are higher so the new supply curve should be S1 and equilibrium moved to P1


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External Benefits / Positive externalities

  • As well as external costs businesses can create external benefits

  • External benefits are advantages a business brings to the local community when it locates its business in a particular area. These benefits will be positive for the local community.

  • Examples:

  • Employment

  • Quality of life

  • Providing a service

  • Regeneration of land


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External Benefits / Positive Externalities

  • If the business was supplying products ignoring social benefits the initial supply curve S1


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External Costs and benefits In production

  • External costs are where MSC = MSB – MPC e.g. pollution, traffic congestion

  • External benefits are where MSC < MPC e.g. research and development in industry, human resource development


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External costs and benefits in consumption

  • External costs = where MSB < MPB e.g. anti-social behaviour, passive smoking, noise

  • External benefits = where MSB > MPB e.g. public transport, vaccinations, attractive surroundings


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Externalities

  • The presence of negative externalities is likely to cause over production of a product

  • The presence of positive externalities is likely to lead to under production of a product

  • Externalities can lead to market failure if the pricing mechanism fails to account for the social costs and benefits of production


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Value of Externalities

  • The value of social costs and benefits can be measured by looking at:

    • Consumer surplus

    • Producer surplus

    • Cost-benefit analysis : what is the balance of costs and benefits

    • Willingness to pay


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Cost Benefit Analysis

  • Identify all costs and benefits

  • Measure the value of all costs and benefits

  • Calculate the likelihood of costs and benefits

  • Analyse the timing of the costs and benefits looking at present value

  • Decide whether the project is worth undertaking


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Public Goods

  • These are services that are provided by the government

  • Pure public goods have the following characteristics:

    • Non excludability – everyone can consume the goods whether they pay or not

    • Non rivalry in consumption – consumption by one person doesn’t reduce consumption for others

  • Examples – street lighting, national defence


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Public goods and Market Failure

  • You cant get an individual to pay for public goods as others can get the benefits from consumption without paying

  • Private companies will not supply public goods as they don’t make an economic profit on them

  • Public goods are only supplied by the government and financed through taxation


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Private goods

  • Private goods have the following characteristics:

    • Excludability – if you don’t pay you can be excluded from consuming the product

    • Rivalry – the consumption of one person reduces the amount available for others to consume

    • Rejectability – you can choose not to consume them and therefore reject them


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Merit goods

  • Merit goods are where social benefits exceed social costs – they generate positive externalities

  • Governments aim to provide more of these goods due to the benefits to society

  • They may subsidise the production of such goods reducing the marginal costs of consumption and therefore increasing demand

  • Examples – healthcare, education


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Merit goods and Market Failure

  • If the government didn’t step in and produce merit goods then they would be under produced

  • Attributable to the fact that individuals do not realise the benefits of consuming these goods


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Demerit goods

  • Demerit goods are where social costs outweigh social benefits – they generate negative externalities

  • Governments try and reduce the consumption of these goods through higher taxes

  • Examples – cigarettes, alcohol


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Market imperfections

  • Monopolies – these are often viewed as allocating resources inefficiently as the producer is able to charge higher prices due to being the only producer in the market

  • Imperfect knowledge of the market can also cause market failure


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Immobility of factors of production

  • These can lead to market failure and may be due to:

  • Occupational immobility – this occurs when there are barriers of mobility between different jobs and different industries

  • Geographical immobility exists when there are barriers to people of moving to different locations


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Inequalities

  • In market economies an individuals ability to consume goods and services is dependent on their income / wealth

  • An uneven distribution of income / wealth within an economy can result in an unsatisfactory allocation of resources and therefore market failure

  • In many developing countries income inequality is great therefore resulting in misallocation of resources


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Summary

  • Externalities are caused when social benefits / costs are different to private benefits / costs

  • Positive externalities occur where social benefits are greater than private benefits

  • Negative externalities occur where social costs are greater than private costs

  • Cost benefit analysis looks at the costs and benefits of producing / consuming a product

  • Public goods are goods that are provided by the government e.g. street lighting

  • Merit goods are where social benefits exceed social costs e.g. healthcare the government encourages people to use these

  • Demerit goods are where social costs exceed social benefits e.g. smoking the government discourages people to use these through taxation

  • Market imperfections can be caused by monopolies, imperfect market knowledge and factor immobility which can result in misallocation of resources

  • Inequalities in wealth and income distribution may result in a misallocation of resources as the rich consume more


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