1. Demonstrate Understanding of Government Interventions to Correct Market Failures

2. Market Failure
Market failure occurs when the market does not result in efficient or equitable outcomes.

3. Efficiency
Efficiency occurs when Social Marginal Cost equals Social Marginal Benefit.
in this Achievement Standard efficiency is about social allocative efficiency rather than the market allocative efficiency studied in other Achievement Standards.
The conditions for the market system to work perfectly are not met so the price/market system will not achieve ‘social’ allocative efficiency.

4. Equity
Equity occurs if a situation or outcome is considered to be fair.
Fairness is a matter of opinion often based on peoples values e.g. some person/group will think its fair to tax high income earners more than low income earners while other people/groups may consider this unfair.

5. Government Intervention
Market failure is a justification for Government intervention into the market system to ‘right the wrongs’

6. Examples of Market Failure
consumers do not always act in their best interests e.g. over consuming alcohol, smoking cigarettes.
producers do not always act in society’s best interests e.g. over polluting, producing unsafe goods
the market may fail to provide the right quantity of certain goods and services e.g. adequate housing and healthcare, public parks.
the market does not ensure everyone earns reasonable income e.g. how do the unemployed receive income?
the market will not ensure that everybody receives an education

7. What are the Different Market Failures?
The different market failures to study are
consumption externalities
production externalities
public goods
imperfect information
inequitable income distribution

8. What are the Different Government Interventions / Policies?
The Government can intervene in markets in a number of ways e.g.
Subsidies
Taxes
Regulations
Establish property rights
Government provision
Welfare benefits

9. Externalities
Externalities are unintended side effects that result from production or consumption
They affect others not directly involved
Externalities can be positive or negative
e.g.
[1] pollution from a factory means a car sales yard has to continually clean its cars. [negative externality]
[2] more people using public transport reduces congestion in the central city for others vehicle users [positive externality]

10. Social Cost and Benefits
Social Cost - Cost to society due to a negative externality.
[also called Spillover Cost]
Social Benefit - benefit to society due to a positive externality.
[also called Spillover Benefit]

11. Externality Model
MC = Marginal Cost [= supply curve] SMC = Social Marginal Cost MB = Marginal Benefit [= demand curve] SMB = Social Marginal Benefit Pp = private market price Qp = private market quantity Qp
Quantity
MB, MC,
SMC,
SMB $ Pp
MB = SMB
MC = SMC

12. What is MC, SMC?
Marginal Costs [MC] – the firms’ extra cost of producing an extra good unit.
Social Marginal Cost [SMC] – represents the firms marginal cost PLUS the spillover/social costs [or benefits] to society from producing that good.

13. What is MB, SMB?
Marginal Benefit [MB] - extra benefit gained by the consumer from the consumption of extra units of a good.
Social Marginal Benefit [SMB]– represents the consumers marginal benefit PLUS the spillover benefits [or costs] to society of consuming the good.

14. Negative Externalities of Production
Cost to society of producing the good is higher than the cost to individual firms e.g. pollution.
producing this good results in spillover costs to society.
In this case SMC > MC
[the Social Marginal Cost is greater than the Marginal Cost]

15. Negative Externalities of Production - Model
SMC = SMB is the socially desirable equilibrium and is allocatively efficient from society viewpoint
Therefore from society’s viewpoint
Price should be Ps [the social price]
Quantity should be Qs [the social quantity] Qs Qp
Quantity
MB, MC,
SMC,
SMB $ Ps Pp
MB = SMB MC
SMC

16. be as shown [blue shaded area including dotted area]
Without any Government intervention the market will continue to produce at Pp and Qp [where SMB = MC]
Therefore the unregulated market will NOT be socially allocatively efficient as SMB ≠ SMC
The market fails as the good is over-produced and under-priced [from society’s viewpoint too much is produced and the price is too low.]
The social cost will
be as shown [blue shaded
area including dotted
area]
The social deadweight loss
equals the dotted area Qs Qp
Quantity
MB, MC,
SMC,
SMB $ Ps Pp
MB = SMB MC
SMC

17. Government Interventions for Negative Externalities of Production
Possible Government Interventions are:
Taxation – tax the sale of the good. This will raise price and reduce consumption to Qs
Regulation – limit the sale or production of the good so only Qs is produced
Education – Government funded education campaigns that inform people about the social costs . This will reduce MB [demand] and therefore consumption/ production falls to Qs
Property Rights – establish property rights so the firm causing the social/spillover costs has to pay the groups affected by the spillover costs or pay for methods to reduce the negative externality. This would raise firm’s costs of production and
they will respond by reducing production back towards Qs .

18. Example of a Government Intervention to Correct a Market Failure using a Model
Negative Externality of Production
e.g. A large industrial factory called Onceler Ltd makes Threads. It is discharging large amounts of pollution into the atmosphere.
Government Intervention
To impose a sales tax on Threads

19. Government Intervention - Model
A sales tax will shift MC to where the SMC curve is.
This will raise the price of Threads to PTax [= Ps] the socially desirable price
This will reduce the quantity of Threads produced to Qtax [ = Qs] the socially desirable quantity.
Now MCTax = SMC = SMB at the socially desirable equilibrium and the market is allocatively efficient from society’s viewpoint.
The social deadweight loss is eliminated and social cost is reduced [blue shaded area] Qs
= QTax Qp
Quantity
MB, MC,
SMC,
SMB $
PTax= Ps Pp
MB = SMB MC
SMC = MCTax

20. Positive Externalities of Production
Cost to society of producing the good is lower than cost to individual firms e.g. bees pollinating a apple orchard so more apples are produced.
Producing this good results in spill-over benefits to society.
In this case SMC < MC
[the Social Marginal Cost is less than the Marginal Cost]

21. Positive Externalities of Production Model
SMC = SMB is the socially desirable equilibrium and is allocatively efficient from society viewpoint
Society benefits from the production of this good therefore from society’s viewpoint
Price should be Ps [the social price]
Quantity should be Qs [the social quantity] Qp Qs
Quantity
MB, MC,
SMC,
SMB $ Pp Ps
MB = SMB
SMC MC

22. Without any Government intervention the market will continue to produce at Pp and Qp [where SMB = MC]
Therefore the unregulated market is NOT socially allocatively efficient as SMB ≠ SMC
The market fails as the good is under-produced and over-priced [from society’s viewpoint too little is produced and the price is too high]
The social benefit
is the blue shaded
area
The social deadweight
loss equals the dotted Qp Qs
Quantity
MB, MC,
SMC,
SMB $ Pp Ps
MB = SMB
SMC MC

23. Government Interventions for Positive Externalities of Production
Possible Government Interventions are:
Subsidise – subsidise the production of the good. This will raise production to Qs and encourage consumption by lowering price
Regulation – make production/consumption compulsory, this will increase production to Qs
Education – Government funded education campaigns that inform people about the social benefits . This will increase MB [demand] and therefore consumption/ production rises to Qs
Property Rights – establish property rights so the firm causing the social/spillover benefits has the right to benefit from the positive externality. This would reduce firm’s costs of production and/or encourage production so production
increases towards Qs.

24. Positive Externalities of Consumption
One person’s consumption benefits others. i.e. the benefit to society is greater than the benefit to the individual.
e.g. using public transport rather than a private vehicle to travel into the city to work has spillover benefits to others as there is less congestion on the roads, noise pollution is less, more parking available etc.
producing this good results in spillover benefits to society.
In this case SMB > MB
[the Social Marginal Benefit is greater than the
Marginal Benefit]

25. Positive Externalities of Consumption - Model
SMC = SMB is the socially desirable equilibrium and is allocatively efficient from society’s viewpoint
Therefore from society’s viewpoint
Quantity should be Qs [the social quantity]
Price should be Ps [the social price] Note: Ps is not at intersection of SMB and MC Qs Qp
Quantity
MB, MC,
SMC,
SMB $ Pp Ps MB
MC = SMC
SMB

26. The social benefit is the blue shaded area The social deadweight loss
Without any Government intervention the market will continue to produce at Pp and Qp [where SMC = MB]
Therefore the unregulated market will NOT be socially allocatively efficient as SMB ≠ SMC
The market fails as the good is under-produced and over-priced [from society’s viewpoint too little is produced and the price is too high].
The social benefit is the
blue shaded area
The social deadweight loss
equals the dotted area Qs Qp
Quantity
MB, MC,
SMC,
SMB $ Pp Ps MB
MC = SMC
SMB

27. Government Interventions for Positive Externalities of Consumption
Possible Government Interventions are:
Susidise – subsidise the production of the good. This will raise production to Qs and encourage consumption by lowering price
Regulation – make production/consumption compulsory, this will increase production to Qs
Education – Government funded education campaigns that inform people about the social benefits . This will increase MB [demand] and therefore consumption/ production rises to Qs
Property Rights – establish property rights so the firm causing the social/spillover benefits has the right to benefit from the positive externality. This would reduce firm’s costs of production and/or encourage production so prodcution
increases towards Qs.

28. Negative Externalities of Consumption
One person’s consumption has a cost to others i.e. the cost to society is greater than the cost to the individual.
e.g. over-consumption of alcohol.
consuming this good results in spillover costs to society.
In this case SMB < MB
[the Social Marginal Benefit is less than the
Marginal Benefit]

29. Negative Externalities of Consumption - Model
SMC = SMB is the socially desirable equilibrium and is allocatively efficient from society’s viewpoint
Therefore from society’s viewpoint
Quantity should be Qs [the social quantity]
Price should be Ps [the social price] Note: Ps is not at intersection of SMB and MC Qs Qp
Quantity
MB, MC,
SMC,
SMB $ Ps Pp
MC = SMC MB

30. be as shown [blue shaded area including dotted area]
Without any Government intervention the market will continue to produce at Pp and Qp [where SMC = MB]
Therefore the unregulated market will NOT be socially allocatively efficient as SMB ≠ SMC
The market fails as the good is over-produced and under-priced [from society’s viewpoint too much is produced and the price is too low].
The social cost will
be as shown [blue shaded
area including dotted
area]
The social deadweight loss
equals the dotted area Qs Qp
Quantity
MB, MC,
SMC,
SMB $ Ps Pp MB
MC = SMC
SMB

31. Government Interventions for Negative Externalities of Consumption
Possible Government Interventions are:
Taxation – tax the sale of the good. This will raise price and reduce consumption to Qs
Regulation – limit the sale or production of the good so only Qs is produced
Education – Government funded education campaigns that inform people about the social costs . This will reduce MB [demand] and therefore consumption/ production falls to Qs
Property Rights – establish property rights so the firm causing the social/spillover costs has to pay the groups affected by the spillover costs or pay for methods to reduce the negative externality. This would raise firm’s costs of production and
they will respond by reducing production back towards Qs .

32. PUBLIC GOODS
Public goods are goods which are non-rival/non-depletable and non-excludable by price.
Non-rival/non-depletable means that if one person uses the good it does not prevent other people from using the good. e.g. street lighting – if one person uses it, other people can still use it.
Non-excludable means goods can not be withheld from those who do not pay e.g. street lights are available for those who do not pay rates.

33. Examples of Public Goods
Roads, footpaths, street lights, public parks
Public goods by their nature result in positive externalities of consumption.
Society benefits from the provision of public goods
Because public goods are non excludable property rights over public goods may be difficult to establish

34. Private Goods Characteristics are :
Consumption is rival/depletable i.e. if one person has the good then it is not available to others
Consumption is excludable by price i.e. if the price is not paid the benefits are not enjoyed.
There are no externalities
Property rights [ownership] is clear.

35. Government Provision of Public Goods
Because public goods are non excludable and non rival it is impossible to charge a price for them. Therefore private firms will not provide public goods as no profit can be made.
Because the market fails to provide public goods the Government has to intervene and provide public goods [through use of taxation]
This ensures society enjoys the benefits of public goods.  

36. Free Rider Behaviour
The refusal to contribute to the cost of a public good on the basis that once it is provided, it is impossible to prevent people from using.
Free riders are consumers who enjoy the benefits of a good without making any payment. This occurs because public goods are non-excludable.
e.g. overseas tourists using public parks

37. Economic Model for Public Goods
The Marginal cost for the next user is zero, so for allocative efficiency to occur the price must be zero
Social allocative efficiency occurs where SMB = MC
At Qs the maximum social benefit is gained form the public good
The social benefit gained is the area [triangle] to the left of SMB
Costs, Benefits $
SMB
MC = 0
Qs Quantity

38. Charging a Price for Public Goods
If a price is charged then only Q1 will be consumed
There is a loss of social allocative efficiency as social benefit is not being maximised [green triangle]
Costs, Benefits $ P1
Loss in social benefit
SMB
MC = 0
Q Qs Quantity

39. Users Pays
Principle that those who use public goods or collective goods should have to pay.
However charging for public goods will result in less consumption/use of public goods and less social benefit is gained.

40. Mixed Goods Collective Goods
are goods that the government provides free of direct charge and which are paid for by taxation
Mixed Goods
a good that have characteristics of both private and public goods.

41. Inequitable Income Distribution
The free market does not ensure that income distribution is equitable. [= market failure]
In the free market some people earn more than enough income to live on, while others do not earn enough.
Equity of income means that people’s incomes are fair [equitable = fair, inequitable = unfair]
Equality of income means that people’s incomes are the same.

42. Can Incomes be Equal?
Equality of income is not a goal of society as it is recognised that if someone works harder/longer/has more skills, responsibilities etc. then this should be rewarded with more income.
However, the Government will attempt to make income distribution fairer [in their opinion] by ensuring the lower paid have enough income to live reasonably.

43. The Lorenz Curve
Lorenz Curves are used to show inequality of income or wealth. The red line is the Lorenz Curve and it shows that income distribution is not equal.
of income

44. Lorenz Curves [continued]
Lorenz curves show how far away distribution of income in a society is from complete equality.
The line of complete equality (45 line) shows all households earning the same income.
The closer the Lorenz curve to the 45 line, then the more equal incomes are.
The Lorenz Curve above [red line] shows income inequality as 50% of income earners earn only 20% of the total income earned or that the top 10% of income earners earn 30% of the income

45. Government Intervention
There are a number of ways the Government intervenes to make incomes distribution fairer.
Progressive income tax - people on higher salaries/wages pay a greater proportion of their income in taxation than those on lower salaries/wages.
Transfer payments such as benefits are paid to the unemployed, the long-term sick etc.
Collective goods may be provided to those on lower income e.g. subsidised housing

46. Government Intervention [cont]
Targeted subsidies may be provided to those on lower incomes e.g. community service cards for health services.
Legislation is enacted e.g. minimum wage of $13.75 per hour for employees aged 16 and older.
Equality of opportunity is promoted e.g. free education and health care to the young.

47. Effect of Government Intervention on the Lorenz Curve
Progressive taxes and paying benefits to low income earners will make income distribution more equal [the Lorenz curve moves inwards]
of income

48. Equity Issues
Government Interventions aimed to make income distribution more equal [e.g. progressive tax rates] can be
[a] Fair or equitable – because people on lower incomes need extra income [after tax] to help them afford the basic necessities of life whereas higher income earners can afford to pay higher tax. Therefore it is fair lower income earners pay lower rates of tax on their income OR
[b] Unfair or inequitable – because high income earners may deserve their higher income through working longer hours, being better qualified, responsibility etc. so why should they pay a higher tax than someone else.

49. Equity - Efficiency Trade-off
Government interventions aimed to make income distribution more equal lead to equity gains but they also lead to efficiency losses
e.g. more progressive tax rates will make income distribution more equal [equity gain] but also creates a disincentive to work for people on higher incomes [efficiency loss].
Efficiency
Equity

50. Imperfect Information
Perfect information means that anything that may impact a buyer or seller's decision making process is known and understood.
Imperfect Information occurs when people have inaccurate, incomplete, uncertain or misunderstood data.

51. Imperfect Information and Market Failure
Market failure exists when some, or all, of the participants in an economic exchange do not have perfect knowledge and so make potentially ‘wrong’ choices.
Market failure also exists when one participant in an economic exchange knows more than the other, [unbalanced, information] and this gives the participant with better information a competitive advantage

52. Examples of Imperfect Information
e.g. persuasive advertising may ‘oversell’ the benefits of a product leading to more consumption than is optimal.
Spam mail may cause misinformation for consumers.
2nd hand car dealer trying to sell a car they know is poor quality
Consumers being unaware of some of the side effects of medication

53. Government Interventions for Imperfect Information
The government has a role in trying to ensure that some of these market failures are reduced or eliminated.
Some interventions include:
producers are required by law to provide accurate information about products through accurate labelling e.g. alcoholic content of drinks is printed on alcoholic drinks
Government funded or subsidised education campaigns to improve knowledge such as informing smokers and drinkers of the true cost of their habit.

54. Government Interventions [continued]
Government may also regulate advertising standards to make advertising more informative, and less persuasive. E.g Fair Trading Act forbids misleading and deceptive advertising
Consumer Guarantees Act protects consumers by ensuring that all goods and services provided by producers are of acceptable quality otherwise they need to be repaired, refunded, replaced.