1.4 Market Failure
If a market is in equilibrium, with no external influences and with no external effects, it is said to be socially efficient as community surplus is maximized. Remember that the welfare of society and it is made up of a consumer surplus and producer surplus. However, in the real world, markets are not perfect. Resources are not allocated in an optimal manner, so community surplus is not maximized.
Market Failure: This occurs when community surplus is not maximized. Governments are often expected to intervene in order to try to eliminate the market failure and move towards the optimal allocation of resources. In this unit we will look at two topics, externalities and public goods can result in market failure.
Market Failure: This occurs when community surplus is not maximized. Governments are often expected to intervene in order to try to eliminate the market failure and move towards the optimal allocation of resources. In this unit we will look at two topics, externalities and public goods can result in market failure.
Externalities
What we will study?
By the end of this unit you should be able to:
What we will study?
By the end of this unit you should be able to:
- Analyse the concept of market failure as a failure of the market to achieve allocative efficiency, resulting in an overallocation of resources (overprovision of a good) or an under-allocation of resources (under-provision of a good).
- Describe the concepts of marginal private benefits (MPB), marginal social benefits (MSB), marginal private costs (MPC) and marginal social costs (MSC).
- Describe the meaning of externalities as the failure of the market to achieve a social optimum where MSB = MSC.
- Explain, using diagrams and examples, the concepts of negative externalities of production and consumption, and the welfare loss associated with the production or consumption of a good or service.
- Explain that demerit goods are goods whose consumption creates external costs.
- Evaluate, using diagrams, the use of policy responses, including market-based policies (taxation and tradable permits), and government regulations, to the problem of negative externalities of production and consumption.
- Explain, using diagrams and examples, the concepts of positive externalities of production and consumption, and the welfare loss associated with the production or consumption of a good or service.
- Explain that merit goods are goods whose consumption creates external benefits.
- Evaluate, using diagrams, the use of government responses, including subsidies, legislation, advertising to influence behaviour, and direct provision of goods and services.
Fracking
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The tragedy of the commons
Market Failure Diagrams Review
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