Market Failure

Copyright 2006 – Biz/ed

Market Failure
• Definition: • Where the market mechanism fails to allocate resources efficiently
– Social Efficiency – Allocative Efficiency – Technical Efficiency – Productive Efficiency

Copyright 2006 – Biz/ed

bized. 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 Copyright 2006 – Biz/ed .co. 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) Copyright 2006 – Biz/ed .

http://www.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 Copyright 2006 – Biz/ed Market Failure • Market Failure occurs where: – – – – – Knowledge is not perfect .bized. 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 Copyright 2006 – Biz/ed .http://www.bized.

bized.http://www.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? Copyright 2006 – Biz/ed .uk Market Failure • Goods/Services are differentiated – Branding – Designer labels .co.

e. London and South East! Copyright 2006 – Biz/ed 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 Market Failure • Market Power: – Existence of monopolies and oligopolies – Collusion – Price fixing – Abnormal profits – Rigging of markets – Barriers to entry Copyright 2006 – Biz/ed .

uk 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? Copyright 2006 – Biz/ed .bized.

uk Market Failure • Merit Goods • Education – nurseries.http://www. 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? Copyright 2006 – Biz/ed . Market Failure • Public Goods • Non-excludability – – Markets would not provide such goods and services at all! Person paying for the benefit cannot prevent anyone else from also benefiting the ‘free rider’ problem A non-excludable good? • Non-rivalry – Large external benefits relative to cost – socially desirable but not profitable to supply! Would you pay for this? Copyright 2006 – Biz/ed .http://www.

co.bized. 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 Copyright 2006 – Biz/ed . 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 Copyright 2006 – Biz/ed

co.http://www. depletion of the ozone layer. drug abuse. environmental degradation.bized. poor housing Copyright 2006 – Biz/ed 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. tobacco. traffic congestion. anti-social behaviour. misuse of alcohol. pollution.

The Marginal Private cost to society is higher than reflect the true cost of Price £12 External Costs MSC = MPC + External Cost £7 £5 Social Cost The Marginal Social Benefit The MPCtherefore does not is take into The true cost the MSC The difference between the curve (MSB) represents the account the cost to society of MPC (the MPC plus external cost). At welfare antherefore output level Current output the levels (100) represents loss consumers in society as a to of 100. externality (Welfare Loss) Socially efficient output is where MSC = MSB MSB 80 100 Quantity Bought and Sold Copyright 2006 – Biz/ed . Cost (MPC) curve represents this (£12). benefits. the private cost to the represent some element of market society ofthe 100 units being whole – private and social supplier is £5 per unit but the failure – price does not accurately produced.bized. value thethe MSB and the MSC sum of benefits to production. the costs negative to suppliers of Value of the producing a given output.

co.http://www. investment in housing maintenance. education and training. refuse collection. health education and preventative medicine.bized. law and order Copyright 2006 – Biz/ed .g. public Market Failure • External benefits – – by products of production and decision making that raise the welfare of a third party – e.

the sum of the benefits to society is greater than the private benefit to the of the positive individual. Price External Benefits MSC Value externality (Welfare Loss) Socially efficient output is where MSC = MSB There can be a position where output is less than would be socially desirable (education for example?) In this £5 Social Benefits MSB MPB 100 140 Quantity Bought and Sold Copyright 2006 – Biz/ed . £10 £6.

uk Market Failure • Inequality: – Poverty – absolute and relative – Distribution of factor ownership – Distribution of income – Wealth distribution – Discrimination – Housing Copyright 2006 – Biz/ed .co.bized.http://www.

co.bized. Market Failure • Measures to correct market failure – – – – – – – – State provision Extension of property rights Taxation Subsidies Regulation Prohibition Positive discrimination Redistribution of income Copyright 2006 – Biz/ed .