2.10 Market failure

           

 

Market failure occurs when the market forces  of demand and supply are unsuccessful in allocating resources efficiently and  cause external costs or external benefits.

Private costs of production and consumption are the actual costs of a firm, individual or government.

External costs are the negative side-effects of production or consumption incurred by third parties for which no compensation is paid.

Social costs are the true (or full) costs of consumption or production to society as a whole,    

                                                  

                            Social cost = private cost + external cost 

Private benefits are the benefits of production and consumption enjoyed by a firm, individual or government.

External benefits are the positive side-effects of production or consumption experienced by third parties for which no money is paid by the benefi ciary.

Social benefiits are the true (or full) benefi ts of consumption or production.

                   Social benefit = private benefit + external benefit 

Public goods are goods and services that are non-excludable and non-rivalrous, and which are a cause of market failure as there is a lack of a profit motive to produce them. e.g street lights, public roads.

Merit goods are goods or services which when consumed create positive spillover effects in an economy. e.g education, vaccinations

Demerit goods are goods or services which when consumed cause negative spillover effects in an economy. e.g cigarettes, alcohol

Causes of market failure: (Key points to identify)

 ● merit goods under-consumed

● demerit goods over-consumed 

● public goods not provided 

● information failure

● existence of externalities

● some people have more influence in a market than others

● existence of monopolies.

Further explaination of above points identified.                                      

Causes of market failure, Consequences and Government Role to Correct it.

"When social costs is greater than social benefits" 

Over-provision of demerit goods 

These are goods which have harmful impacts on consumers/society. For example alcohol, drugs, sugary foods/drinks. They are over-produced in a market and their consumption often creates external costs Governments often have to regulate these goods in such a way that they raise the prices and/or limit the quantities consumed.

Under-provision of merit goods 

Merit goods are beneficial to the society but consumers actually under-consume them as they do not fully recognise or understand the private or external benefits

For example healthcare, education. They are under-provided in a market & their consumption generates both private and/or external benefits

Governments often have to subsidise these goods in order to lower the price and/or increase the quantities consumed

Lack of public goods : 

Public goods are beneficial to society provided by government since their consumption cannot be measures and charged a price for, as there is little opportunity for sellers (private firms) to make profits from providing these goods/services as they are *non-excludable and **non-rivalrous in consumption, so under-produced. For example as roads,street lights

Therefore, governments usually set a provision to provide these beneficial public goods to address market failure.

*Non-excludability refers to the inability of private firms to exclude certain customers from using their products. In effect, the price mechanism cannot be used to exclude customers for example street lights

**Non-rivalry refers to the inability of the product to be used up, so there is no competitive rivalry in consumption to drive up prices and generate profits for firms

Immobility of resources: when resources cannot move between their optimal uses and thus are not used to the maximum. For example, when workers (labour) don’t have occupational or geographic mobility.

Information failure:  when information between consumers, producers and the government are not efficiently and correctly communicated. Example: a cosmetics firm advertises its products as healthy when it is in fact not. The consumers who believe the firm and use its products might suffer skin damage.

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