Prepared by:Dr.Hassan Sweillam Market Failure Prepared by:Dr.Hassan Sweillam Market failure

Market Failure The conditions under which competitive markets may fail to be optimal institutions to produce and distribute goods. This topic is known as “market failure.” Market failure

Market Failure We saw that the presence of monopoly, for example, could justify government interference because monopolies don’t produce output levels where MSB = MSC. But even competitive markets may fail under some circumstances. Market failure

EXTERNALITIES An externality is a benefit or cost to third parties who are not directly involved in a transaction. Externalities are sometimes called neighborhood effects. Externalities can be either beneficial or harmful, and can originate with either consumers or producers. Here are some examples: Market failure

How Externalities Work The existence of an externality creates a difference between either : a) the private and social cost of production, or b) the private and social benefits from consumption. The consequence is that even competitive markets will fail to reach a social optimum. Market failure

How Externalities Work Marginal external cost is the extra social cost (over and above the private cost) of producing one more unit of the good. Marginal external benefit is the extra social benefit of consuming one more unit of a good. The presence of external benefits and costs means there will be a difference between the private and social consequences of production. Market failure

How Externalities Work Solutions to externalities problems: 1) Economists generally favor taxes and subsidies linked to the value of the externality. 2) Direct regulation. 3) Subsidize pollution control equipment. 4) Sell or grant tradable pollution rights. 5) Internalize the externality through mergers. Market failure

PUBLIC GOODS A public good is a good or service that is consumed in its entirety by everyone. When one person consumes another unit of a public good we all consume more. The most common example is national defense, Polis services , sewage system. Market failure

PUBLIC GOODS Public goods have two special properties compared to private consumption goods. Nonrivalry: When one person consumes a unit of a public good the amount available to be consumed by everyone else is not diminished. Nonexcludability: Once a public good is produced it is difficult or impossible to exclude people from consuming it. Market failure

PUBLIC GOODS Because public goods are nonrival and/or nonexcludable, these goods will tend to be under produced, or maybe not produced at all if left to the private market. Public goods are not the same as publicly provided goods. Just because government provides a good does not make it a public good. Market failure

PUBLIC GOODS Some public goods can be excludable but not rival: 1) Crossing a toll bridge when it isn’t crowded. 2) Scrambled on the air TV signals. One way to explain nonrivalry in consumption is by saying that the marginal cost of providing the good to one more consumer is zero. Market failure

Some public goods may be non excludable but rival: 1) Air that is polluted by smoking. 2) The ocean is not excludable, but fishing is rival. Market failure

PUBLIC GOODS If public goods are produced in private markets, they will be under produced because social benefits will exceed private benefits. Solutions to the public goods problem: 1) Using technologies that provide for exclusion (toll roads, cable TV) 2) Government ownership Market failure

Review questions True or False Questions 1- Perfectly competitive markets is that competition results in output levels for which marginal social benefit greater than marginal social cost. Answer: False 2- An externality is a benefit or cost to third parties who are directly involved in a transaction. 3- A Public good is a good or service that is consumed in its entirety by everyone. Answer: True

Review questions Multiple Choice Questions 1- __________ is the extra social cost (over and above the private cost) of producing one more unit of the good. A- Marginal external benefit B- Marginal external cost C- Externalities D- None of these Answer: B

Review questions Multiple Choice Questions 2- __________ is the extra social benefit of consuming one more unit of a good. A- Marginal external benefit B- Marginal external cost C- Public good D- None of these Answer: A

Review questions Multiple Choice Questions 3- __________ When one person consumes a unit of a public good the amount available to be consumed by everyone else is not diminished. A- Marginal external benefit B- Nonexcludability C- Nonrivalry D- None of these Answer: C

Review questions Brief explain Questions 1- Briefly explain the market failure? 2- Briefly explain the Marginal external cost and benefit? 3-Briefly explain the special properties of Public goods? Brief explain Questions