1. Effectiveness of policies
MARKET FAILURE
Effectiveness of policies
Policies to correct
Reasons for failure
5 most important
points
Deadweight Loss
Monopolies

2. Reasons for Failure
• Monopoly Power / Imperfect Competition• Negative Externalities from production and consumption• Positive Externalities from production and consumption• Immobility of Factors of Production (both geographical and occupational)• Market provision of pure Public Goods and quasi Public Goods• Merit Goods and Services and De-Merit Goods• Imperfect and Asymmetric information in markets (leading to information failure)• Missing markets (e.g. absent markets in some environmental resources)
Definition of market failure
When the operation of a market does not lead to economic efficiency

3. Monopolies & Market Failure
Deadweight Loss
Remember the following:
MC = MR – Maximum Profit or Minimum Loss MC = AR – Allocative Efficiency (Supply = Demand)AC = AR – Breakeven PointAC = MC – Technical Optimum – Productive Efficiency MC P2 P1 AR MR Q2 Q1

4. Deadweight loss Loss of Consumer & Producer Surplus S+Indirect TaxQ2 Q1
Loss of Consumer & Producer Surplus

5. Government Intervention
From the AS course:
Maximum Prices - Price Stabilisation - Taxes & Subsidies - Direct Provision.
Reasons for intervention:
Restore economic efficiency - increase equity
Failure
Consequence
Intervention
Market Power
P↑Q ↓
Competition Policy
Merit Goods
Underprovided
Subsidy Legislation
Negative Externalities
Overproduced
Taxes Legislation
Instability
Price fluctuations
Buffer stocks
Inequality
unequal distribution
Taxes Subsidies

6. Regulation of monopolies
1. Outlaw formation of Monopolies - Commerce Commission in NZ
2. Predatory Pricing - pricing below competition to eliminate competition
3. Guaranteed quality of goods and services
4. Insist on certain levels of competition in a market

7. Redistributing Income & Wealth
1. Social Security benefits and pensions.
2. Provision of goods and services
3. Taxation - progressive income tax
4. Legislation - minimum wage and equal pay legislation
5. Training - may improve wages in long term.
Equity - Efficiency Trade-Off
Intervention in the market by government is to reduce the uneven distribution. Subsidies to lower income groups and taxes on higher income groups maybe regarded as socially desirable but they are interfering with the market and therefore are actually creating inefficiency.
BUT - inefficiencies that exist already in the market (externalities monopolies) - intervention may improve efficiency overall.

8. Problems of Government intervention
1. Lack of Information
2. Difficulty quantifying problems
3. Mistiming
4. Administration costs
5. Political pressure

9. Exam Questions
4. Large firms necessarily become monopolistic. Monopolies adopt practices that are undesirable. Therefore, large firms should be regulated by governments.
Discuss whether there is any truth in this argument. [25] June 2008
Large firms not necessarily monopolisitic - size of market important. Could be a contestable market.
Large firm can achieve economies of scale - lower price for consumers.
Supernormal profits gives the firm the ability to invest - improve efficiency and R&D
May have to innovate to keep competition out BUT Predatory pricing
Large can drive up price MC=MR to detriment of consumers - not producing at MC=AR but as MC=MR - DWL - graph here
Gov’t regulation depends on market power - needs to have correct information about the market.
Will intervention improve efficiency???

10. Exam Questions
2. In 2007 the UK Competition Commission indicated that failure in the market mechanism would result in both winners and losers. (a) Explain why producers are usually the winners and consumers are usually the losers when the market fails. [12]
Market clearing D=S perfect information and perfect markets.
Imperfect markets and imperfect information market failure occurs.
Monopoly influences with resulting higher profits for producers but higher prices for consumers – and with possibly less choice.
Externalities which may affect consumers but would not necessarily have to be accounted for by producers. It could be from a lack of information – it is likely that producers will have more information about the effects of a product than consumers.
(b) Discuss what the government might do when there are losers because the market mechanism has failed. [13] June 2010
Regulation, taxation, information, controls etc. For and against here

11. Exam Questions
4 In India the post is delivered partly by private courier firms and partly by the government-owned India Post. The government is keen to increase its share of the market. (a) Explain why a government might wish to increase its control over private firms. [10]
Availability of product to all - private sector restricted services - important for the economy - make it more efficient mention productive and allocative - private sector not allocative - supernormal profits being earned - regulate health and safety issues
(b) Discuss whether an increase in government control necessarily improves efficiency in an organisation. [15] Nov 2008
Is it already efficient? If firm restricting output and earning large supernormal profit gov’t intervention needed. Increase consumer surplus move towards allocative efficiency - graph here. Gov’t failure also - lack of information - over estimates negative externalities - high tax might reduce firms from investing etc. Political Popularity ?