Market Failure

Expected Learning outcome

By the end of the lesson you should be able
to:
a)Define market failure;
b)List sources of market failure;
c)Define public goods
d)Explain characteristics of public goods
e)Evaluate the extent to which Non-provision
of public goods may lead to market failure.
Expected Learning outcome
Eco
nom • What is an economic system
ic
Syst
em

• Name 3 main types of economic systems

TYP that exists around the world. With examples
ES

• Do you think there is a country without a

WH government or a government like authority?
AT • Which economic system is likely to fail
FAIL
S
Meaning of Market Failure
Market failure occurs when the free market
forces of demand and supply(free market
system), fails to allocate resources
efficiently, leading to under/over
production or consumption of goods
than the social optimum.

This can be partial or full failure.

Full failure is where the free market creates
missing markets.
i.e markets that have demand but no supply.
Non Provision of Public Goods
• Think of goods or services that WILL NOT BE
Pub PROVIDED AT ALL if there was no
lic government in your country.
Goo
d?
• Think of goods or services that WILL BE
Zer PROVIDED BUT NOT IN ENOUGH
o QUANTITIES if there was no government in
Pro your country.
visi
on

Part • WHAT ARE THE REASONS YOU THINK THEY

ial WILL NOT BE PROVIDED BY PRIVATE FIRMS
Pro
visi
on
Non Provision of Public Goods
A public good is a good that can be consumed
by everyone, regardless of whether they have
paid it or not.

One way the free market system fails is

through the non-provision of public goods

Example of public goods:

 Street lighting
 Lighthouse Protection,
 Police services,
 National defense
 Air defence systems,
 Roads/motorways,
 Flood defence systems,
 Public parks and beaches ETC
Characteristics of Public Goods
Public goods have two main
characteristics namely
1) Free rider problem/Non-excludability
2) Non rivalry
Characteristics of Public Goods
Free rider problem /Non-excludability

i. Can you be stopped from using the street lights in

Kenya if you aren’t paying taxes/fees in Nairobi?

ii. Can you be stopped from using the highway in

Kenya if you aren’t paying taxes/fees?

iii. Can you be stopped from reporting a case to a

police station if you aren’t paying taxes/fees?

iv. Any other good that has this characteristic?

Characteristics of Public Goods
Free rider problem /Non-
excludability
The goods cannot be confined to
those who have paid for them.

In a free market, public goods are

not provided by private producers
because the supplier cannot prevent
consumption by people who do not
pay for them.
Non rivalry in consumption
i. Will the amount of street light reduce
or get finish as more people use it?

ii. Will the space on the highway/road

get finished as more people use it?

iii. Will the space on the public parks

get finished as more people use it?
iv. Name any other good with this
characteristic.
Characteristics of Public Goods
Non rivalry in consumption
The consumption of one individual does
not reduce the quantities available to
others.
• Free markets will only form when
consumers are forced to compete
with each other to obtain the benefit
of the good or service, given that its
supply can be exhausted before they
get it.
 Sources of Market Failure
1) Externalities
2) Non-provision of public goods
3) provision of Merit and demerit goods
 Introduction
Think of any production or
consumption activity where:
1) You have benefited indirectly or
indirectly without being directly
involved in the activity

2) You have suffered or paid the

price directly or indirectly
without being directly involved
in the activity
 Externalities
Externalities refer to positive or negative
effects to third parties, arising from private
production and consumption of firms and
individuals.
They are also called the spillover effects of
production and consumption.
--------------------------------------------------
So how does this lead to failure?
Private, External and Social Costs

Video link:
• Traffic congestion in Nairobi
• China air quality

OWNING A CAR
1. What is the cost of owning a car? Who
pays for it?
2. Does it cost someone else anything when
you own a car?
3. How does it impact other people/third
parties? How do other people lose or
suffer from you owning a car?
Private, External and Social Costs
Private costs:
These are the costs to a private individual arising from
the private consumption or production of a good or
service.
E.g. the private cost of buying a soda is the amount paid
to produce or consume a soda.

External costs /Negative Externalities:

These are the negative effects on third parties arising
from the private production or consumption of individuals
and firms.
For example,
Pollution
Congestion
when you have to spend money to treat illness arising
from secondary smoking.

Social costs:
These are the costs to the whole society arising from the
Private, External and Social Benefits
OWNING A CAR
1. How do you benefit from owning a
car?
2. Who enjoys the benefits of owning a
car
3. Does it benefit someone else/third
party when you own/buy a car?
How?
Private, External and Social Benefits
Benefits are derived from demand and consumption and
production of a good.
These can be classified as:
Private benefits:
These are the benefits to an individual arising from the private
consumption or production of a good or service.
E.g. the private benefit of buying a soda is the satisfaction
derived by the individual buyer.

External benefits:
These are the unintended benefits to third parties arising from
the private production or consumption of individual and firms.
For example, when you get education, you can get a job that
pays a reasonable income (i.e. there is a private benefit to
education); however, that you may also benefit wider society if
you becomes a researcher and discover medicines for HIV
Social benefits:
These are the benefits to the whole society arising from the
private activities of firms and individuals.
Social benefits=Private benefits + External benefits
Positive and negative externalities
. Positive externalities/External benefits

These are the benefits to 3rd Parties

arising from private consumption or
production. I.e. the positive spillover
effects to 3rd parties.
Positive externalities: Examples
Examples of positive consumption externalities For:

1) Education
The many benefits of your education spill over to society in the
form of

a) An educated community may have better standards of living

hence lower crime rates.

b) An educated population is likely to be more productive hence

benefiting the firms.

c) Educated individuals may benefit a society by finding

solutions beneficial to the community e.g. Cancer vaccines.
Positive externalities: Examples
Examples of positive consumption
externalities For:
1) Education
The many benefits of your education spill over
to society in the form of
d) Higher hygiene standards adopted by a
more educated individual may reduce the
spread of disease to others,

e) More educated people means less tax

burden imposed on all members of society.
Positive externalities: Examples
Examples of positive consumption externalities For:
2) Healthcare
Health-based positive externalities arise when individual
actions unintentionally lead to collective well-being for a society.
For example
a) Vaccination: When a significant portion of the population
gets vaccinated, it becomes difficult for a disease to
spread, creating a protective effect for everyone, including
those unvaccinated.

b) Health Screenings: Individual decisions for regular health

checks can reduce the spread of contagious diseases,
through early detection hence benefiting the wider
community.
. Negative Externalities
These are the negative effects to 3rd
Parties arising from private
consumption or production.
Negative externalities: Examples
a)Identify any 2 negative
externalities from this
business activity.
b) In a free market, how
will these private investors
fail while deciding what to
produce, how to produce
and for whom to produce?
c)How would the presence
of a government reduce
this failure
Negative externalities Examples
1) Noise and air pollution e.g from
a) Factories
b) Cars etc

2) Environmental damage: e.g

1) Emission of factory wastes into rivers
2) Destruction of forests and natural habitats

3) Congestion e.g.
a) Increased human and vehicle traffic, especially in
urban areas for work or business.

4) Increased health hazards to humans and

animals
THANK YOU