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Market Failure. Market Failure. Definition: Where the market mechanism fails to allocate resources efficiently Social efficiency Allocative Efficiency Technical Efficiency Productive Efficiency. Market Failure. Social Efficiency = where external costs and benefits are accounted for

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Market Failure

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Market Failure


Market Failure

  • Definition:

  • Where the market mechanism fails to allocate resources efficiently

    • Social efficiency

    • Allocative Efficiency

    • Technical Efficiency

    • Productive Efficiency


Market Failure

  • Social Efficiency = where external costs and benefits are accounted for

  • Allocative Efficiency = where society produces goods and services at minimum cost that are wanted by consumers

  • Technical Efficiency = production of goods and services using the minimum amount of resources

  • Productive Efficiency = production of goods and services at lowest factor cost


Market Failure

  • Allocative efficiency:

    • Also referred to as

  • Pareto Efficient Allocation – resources cannot be readjusted to make one consumer better off without making another worse off – zero opportunity cost!

    • After Vilfredo Pareto (1848 – 1923)


Market Failure

  • Market Failure occurs where:

    • Knowledge is not perfect - ignorance

    • Goods are differentiated

    • Resource immobility

    • Market power

    • Services/goods would or could not be provided in sufficient quantity by the market

    • Existence of external costs and benefits

    • Inequality exists


Market Failure

  • Imperfect Knowledge:

    • Consumers do not have adequate technical knowledge

    • Advertising can mislead or mis-inform

    • Producers unaware of all opportunities

    • Producers cannot accurately measure productivity

    • Decisions often based on past experience rather than future knowledge


Market Failure

  • Goods/Services are differentiated

    • Branding

    • Designer labels - they cost three times as much but are they three times the quality?

    • Technology – lack of understanding of the impact

    • Labelling and product information

Which one is the ‘quality’ item and why?


Market Failure

  • Resource Immobility

    • Factors are not fully mobile

    • Labour immobility – geographical and occupational

    • Capital immobility – what else can we use the Channel Tunnel for?

    • Land – cannot be moved to where it might be needed – e.g. London and South East!


Market Failure

  • Market Power:

    • Existence of monopolies and oligopolies

    • Collusion

    • Price fixing

    • Abnormal profits

    • Rigging of markets

    • Barriers to entry


Market Failure

  • Inadequate Provision:

  • Merit Goods and Public Goods

    • Merit Goods – Could be provided by the market but consumers may not be able to afford or feel the need to purchase – market would not provide them in the quantities society needs

    • Sports facilities?


Market Failure

  • Merit Goods

  • Education – nurseries, schools, colleges, universities – could all be provided by the market but would everyone be able to afford them?

Schools: Would you pay if the state

did not provide them?


Market Failure

  • Public Goods

    • Markets would not provide such goods and services at all!

  • Non- excludability – Person paying for the benefit cannot prevent anyone else from also benefiting - the ‘free rider’ problem

  • Non- rivalry –

    Large external benefits relative to cost – socially desirable but not profitable to supply!

A non- excludable good?

Would you pay for this?


Market Failure

  • De-Merit Goods

  • Goods which society over-produces

  • Goods and services provided by the market which are not in our best interests!

    • Tobacco and alcohol

    • Drugs

    • Gambling


Market Failure

  • External Costs and Benefits

  • External or social costs

    • The cost of an economic decision to a third party

  • External benefits

    • The benefits to a third party as a result of a decision by another party


Market Failure

  • External Costs

  • Decision makers do not take into account the cost imposed on society and others as a result of their decision

    • e.g. Pollution, traffic congestion, environmental degradation, depletion of the ozone layer, misuse of alcohol, tobacco, anti-social behaviour, drug abuse, poor housing


External Costs

Price

MSC + MPC

MPC

£12

Value of the negative

externality(Welfare Loss)

Social Cost

£7

£5

Socially efficient output is where

MSC = MSB

MSB

80

100

Quantity Bought and Sold


Market Failure

  • External benefits –

    • by products of production and decision making that raise the welfare of a third party

    • e.g. Education and training, public transport, health education and preventative medicine, refuse collection, investment in housing maintenance, law and order.


External Benefits

Price

MSC

Value of the positive

externality(Welfare Loss)

£10

Social Benefits

£6.50

Socially efficient output

is where

MSC = MSB

£5

MSB

MPB

100

140

Quantity Bought and Sold


Market Failure

  • Inequality:

    • Poverty – Absolute and Relative

    • Distribution of factor ownership

    • Distribution of Income

    • Wealth Distribution

    • Discrimination

    • Housing


Market Failure

  • Measures to Correct Market Failure

    • State Provision

    • Extension of property rights

    • Taxation

    • Subsidies

    • Regulation

    • Prohibition

    • Positive Discrimination

    • Redistribution of Income


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