2Market Failure Definition: Where the market mechanism fails to allocate resources efficientlySocial EfficiencyAllocative EfficiencyTechnical EfficiencyProductive Efficiency
3Market FailureSocial Efficiency = where external costs and benefits are accounted forAllocative Efficiency = where society produces goods and services at minimum cost that are wanted by consumersTechnical Efficiency = production of goods and services using the minimum amount of resourcesProductive Efficiency = production of goods and services at lowest factor cost
4Market Failure Allocative efficiency: Also referred to asPareto 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)
5Market Failure Market Failure occurs where: Knowledge is not perfect - ignoranceGoods are differentiatedResource immobilityMarket powerServices/goods would or could not be provided in sufficient quantity by the marketExistence of external costs and benefitsInequality exists
6Market Failure Imperfect Knowledge: Consumers do not have adequate technical knowledgeAdvertising can mislead or mis-informProducers unaware of all opportunitiesProducers cannot accurately measure productivityDecisions often based on past experience rather than future knowledge
7Market 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 impactLabelling and product informationWhich one is the ‘quality’ item and why?
8Market Failure Resource Immobility Factors are not fully mobile Labour immobility – geographical and occupationalCapital 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!
9Market Failure Market Power: Existence of monopolies and oligopolies CollusionPrice fixingAbnormal profitsRigging of marketsBarriers to entry
10Market 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 needsSports facilities?
11Market 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 statedid not provide them?
12Market 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’ problemNon-rivalry –Large external benefits relative to cost – socially desirable but not profitable to supply!A non-excludable good?Would you pay for this?
13Market 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 alcoholDrugsGambling
14Market Failure External Costs and Benefits External or social costs The cost of an economic decision to a third partyExternal benefitsThe benefits to a third party as a result of a decision by another party
15Market Failure External Costs Decision makers do not take into account the cost imposed on society and others as a result of their decisione.g. pollution, traffic congestion, environmental degradation, depletion of the ozone layer, misuse of alcohol, tobacco, anti-social behaviour, drug abuse, poor housing
16External Costs Price Value of the negative externality (Welfare Loss) MSC = MPC + External CostPriceThe Marginal Social Benefit curve (MSB) represents the sum of the benefits to consumers in society as a whole – the private and social benefits. The Marginal Private Cost (MPC) curve represents the costs to suppliers of producing a given output.The true cost therefore is the MSC (the MPC plus the external cost). Current output levels therefore (100) represent some element of market failure – price does not accurately reflect the true cost of production.The MPC does not take into account the cost to society of production. At an output level of 100, the private cost to the supplier is £5 per unit but the cost to society is higher than this (£12).The difference between the value of the MSB and the MSC represents the welfare loss to society of 100 units being produced.MPC£12Value of the negativeexternality (Welfare Loss)Social Cost£7£5Socially efficient output is whereMSC = MSBThe slide has been designed to try to lead students through the distinction between the private costs of production and the social cost. The diagram starts out with a basic supply and demand position with price at £5 and Quantity at 100. The demand curve has been labelled MSB – a brief explanation of the concept here is useful. The supply curve is the marginal private cost – the cost to the producer. To try to link the theory to the practice it is suggested that the item in question is the production of rolls of Clingfilm! The reason is that in producing cellophane products there is an amount of air pollution. If students are told that the cost to the producer of manufacturing 100 rolls of Clingfilm is £5 (don’t forget to remind them that this figure includes the element of profit they make) but, the company do not take into consideration the cost imposed on society of the pollution they cause. This cost is then highlighted by a dashed line moving up from the bottom and is priced at £12 . The supply curve that considers the true cost (the MPC and MSC) is then drawn in and the right brace appears to indicate the extent of the social cost (£7).The welfare loss triangle is then imposed – this may need to be explained and students could be reminded of the work done on consumer surplus to help reinforce the concept of the ‘value’ here. Finally, the socially efficient output is highlighted; students can be told that there would be benefits to society if less were produced but that we would be paying more as a result!MSB80100Quantity Bought and Sold
17Market Failure External benefits – by products of production and decision making that raise the welfare of a third partye.g. education and training, public transport, health education and preventative medicine, refuse collection, investment in housing maintenance, law and order
18External Benefits Price MSC Value of the positive There can be a position where output is less than would be socially desirable (education for example?) In this case, the sum of the benefits to society is greater than the private benefit to the individual.MSCValue of the positiveexternality (Welfare Loss)£10Social Benefits£6.50Socially efficient outputis whereMSC = MSB£5This slide looks atMSBMPB100140Quantity Bought and Sold
19Market Failure Inequality: Poverty – absolute and relative Distribution of factor ownershipDistribution of incomeWealth distributionDiscriminationHousing
20Market Failure Measures to correct market failure State provision Extension of property rightsTaxationSubsidiesRegulationProhibitionPositive discriminationRedistribution of income