A.S 3.3 Describe and illustrate resource allocation via the public sector to compensate market failure

Why does the government intervene? The free market is not always able to achieve allocative efficiency. – Market Failure An allocative efficient point is where All resources are allocated to their most efficient use All markets are in equilibrium The economy is operating on its production possibility curve. It is not possible to make someone better off without making someone else worse off (Society’s well being is maximised) This situation is also called Pareto efficiency We will be looking at situations where it is possible to make someone better off without making someone else worse off. This is when governments intervene in the market.

Conditions for the market to achieve allocative efficiency Requires clear price signals Requires clear price signals There must be  Perfect Competition  Perfect Information  Perfect Mobility  Consumer Sovereignty  No Externalities or public goods Reading Price Signals

Market Failure Market Failure can occur from any of the following Market Failure can occur from any of the following The existence of imperfect market structures The existence of imperfect market structures Externalities Externalities Public Goods Public Goods Merit and Demerit goods Merit and Demerit goods Situations where the market leads to inequitable (unfair) outcomes Situations where the market leads to inequitable (unfair) outcomes

Market Failure Markets can fail in a number of ways Markets can fail in a number of ways Some products may be under produced or not produced at all. ie parks Some products may be produced or over produced but are not wanted by society ie drugs The production and consumption of some products affect third parties. ie pollution and smoking cigarettes. The distribution of market income may not enable all citizens to participate meaningfully in society

Market Failure Market failure provides governments with the reason to intervene in the economy or in particular markets that are failing. Market failure provides governments with the reason to intervene in the economy or in particular markets that are failing. Government intervention aims to overcome the failure of markets to move towards a more allocatively efficient position Government intervention aims to overcome the failure of markets to move towards a more allocatively efficient position

Types of Government Intervention Taxation Public Provision Regulation Education and social marketing campaigns Transfer Payments Subsidies Establish Property Rights

Government Intervention Four functions of the government Four functions of the government 1. Legislative/Regulator Role Legal Framework Legal Framework Providing a framework so buyers and sellers know their rights and obligations – enables fair dealing. Legal system used to clarify, define and enforce property rights. Providing a framework so buyers and sellers know their rights and obligations – enables fair dealing. Legal system used to clarify, define and enforce property rights. Promoting Competition Promoting Competition Commerce Commission. Commerce Commission. Correcting for externalities Correcting for externalities

Government Intervention 2. Allocative Role Governments allocate resources that the market fails to produce in sufficient quantities 3. Distributive Role Governments aim to promote equity (fairness) This may be done through redistribution of incomes 4. Stabilisation Role Government aims to provide a stable economic environment

Indicate which Government Function is being done when…. cuts taxes to reduce unemployment specifies that a manufacturer is liable for any harm caused by its product places a tax on a steel producer’s pollution legislates that it is illegal to discriminate on the basis of gender, ethnicity or sexual orientation imposes a wage/price freeze provides funding for a job search scheme provides benefits for low income families provides childcare funding to allow women to work legislates to prevent misleading advertising prevents large companies from merging

Range of Government Interventions Method Effect/ what it is Best for: Subsidy Sales Tax Income Tax Regulations Transfer Payments Public Ownership/ Provision Lowers the cost of production Lowering the price to encourage the production and use of certain products. More resources are allocated to a good/service than would be provided by the free market. Increases the cost of production Raises the price to discourage the production and use of certain products. Pay for some of the costs imposed on society as a result of the product being consumed Reduces IncomesReduces demand. Progressive taxation narrows the gap between rich and poor and reduces inequality of income More direct effect than taxes or subsidies Limit or prohibit the production or consumption of certain products. Enforce the production or consumption of certain products Redistribution of incomes from “rich to poor” Addressing income inequality in form of social welfare benefits and income support. Situations where its not socially desirable for provision to be in private ownership. Providing G&S not sufficiently provided by the free market Army, Police Libraries, parks, Rubbish collection, Education

Externalities The are two parties in the market Producers and Consumer Producers and Consumer Externalities are costs or benefits that affect those other than the consumer or producer (the third party) Externalities are costs or benefits that affect those other than the consumer or producer (the third party) These costs or benefits are not taken into account in the costs of production or consumption. These costs or benefits are not taken into account in the costs of production or consumption. Externalities are also known as “Spillovers” as the cost or benefit spills over from the producer or the consumer Externalities are also known as “Spillovers” as the cost or benefit spills over from the producer or the consumer

Negative Externalities of Production Costs that are imposed on third parties as a result of productive activity Costs that are imposed on third parties as a result of productive activity The well being of third party is reduced – this is the cost The well being of third party is reduced – this is the cost These costs to third parties are not taken into account by producers and therefore no compensation is paid These costs to third parties are not taken into account by producers and therefore no compensation is paid Too much of these goods will be produced. Too much of these goods will be produced.

The Effect of Externalities- Negative Externalities of production MSC  The social costs of production are greater than the private costs of production  The free market will under price and over produce the good when compared with the socially desirable price and output.  Pollution

Positive Externalities of Production Benefits that are gained by third parties as result of productive activities Benefits that are gained by third parties as result of productive activities The well being of the third party is increased- this is the benefit The well being of the third party is increased- this is the benefit Producers are not able to charge for the benefits but third parties can still enjoy benefits for free Producers are not able to charge for the benefits but third parties can still enjoy benefits for free As a result too little of these goods will be produced. As a result too little of these goods will be produced.

The Effect of Externalities- Positive Externalities of Production MSC The social costs of production are less than the private costs of production The free market will over price and under produce the good when compared with the socially desirable price and output Tree Planting

Negative Externalities of Consumption Costs imposed on third parties as a result of consumption Costs imposed on third parties as a result of consumption These costs are avoidable by consumers but do not directly affect the consumer These costs are avoidable by consumers but do not directly affect the consumer These costs are not taken into consideration by the consumer in the decision making process These costs are not taken into consideration by the consumer in the decision making process Too much of these types of goods will be consumed Too much of these types of goods will be consumed Can u think of some examples of negative consumption externalities? Can u think of some examples of negative consumption externalities?

The Effect of Externalities- Negative Externalities of Consumption MSB The social benefits of consumption are less than the private benefits of production The free market will under price and over produce the good when compared with the socially desirable price and output level Smoking

Positive Externalities of Consumption Benefits gained by third parties as a result of consumption Benefits that consumers create but have no way of being compensated for by those who benefit at no cost Benefits that consumers create but have no way of being compensated for by those who benefit at no cost Too less of these goods will be consumed as all the benefits of consumption are not taken into account in decision making process Too less of these goods will be consumed as all the benefits of consumption are not taken into account in decision making process

The Effect of Externalities- Positive Externalities of Consumption SMB Social benefits of consumption are greater than the private benefits of consumption The free market will over price and under produce the good when compared with the socially desirable price and output level Using public transport

Externalities Can u think of some examples of negative production and consumption externalities? Can u think of some examples of negative production and consumption externalities? Can u think of some examples of positive production and consumption externalities? Can u think of some examples of positive production and consumption externalities?

The effect of externalities What effects our decision making process? What effects our decision making process? Producers decisions are based on their Marginal costs Producers decisions are based on their Marginal costs Consumers benefit from consumption and their decisions are based on their Marginal benefits. Consumers benefit from consumption and their decisions are based on their Marginal benefits. When externalities are present the true costs or benefits to society may not be reflected in individual MB and MC curves. When externalities are present the true costs or benefits to society may not be reflected in individual MB and MC curves.

Types of Goods Private Goods Mixed Goods Public Goods

Natural Monopolies

Free Rider Problem

Merit Goods

Demerit Goods

Measures to improve equity