2.D.MARKET FAILURE
The meaning of market failure and externalities
- Analyse the concept of market failure as a failure of the market to achieve allocative efficiency, resulting in an over-allocation of resources (over-provision 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, and 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.
Watch the following video and stop the video at .... iN GROUPS DISCUSS 4 SUGGESTIONS FOR INCENTIVES A VACCINE AND ITS CONSUMPTION.
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| market-failure.doc |
| market_failure_diagrams_from_tragakes.pptx |
Externalities
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MSB=MSC = ALLOCATIVE EFFICIENCY
EXTERNAL COSTS THIRD-PARTIES |
Negative externalities of production and consumption
- 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, and 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.
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Positive externalities
Positive 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.
Task 1: From the images below, draw a diagram for a positive consumption externality and production externality from the examples below:
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Public Goods
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RIVALRY
NON-EXCLUDABILITY DIRECT PROVISION |
Public Goods
- Define a public good.
- Using the concepts of rivalry and excludability, and, providing examples, distinguish between public goods (non-rivalrous and non-excludable) and private goods (rivalrous and excludable).
- Explain, with reference to the free rider problem, how the lack of public goods indicates market failure.
- Discuss the implications of the direct provision of public goods by the government.
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TOK: IS ACADEMIA FREE FROM MYTHOLOGY?
What is mythology?
How do myths develop?
How important is mythology to indigenous knowledge systems?
What are the strengths and weaknesses of mythology as a source of knowledge in indigenous knowledge?
Does mythology exist in areas of knowledge that you study in the IB?
Does this pose a problem in subjects that refer to themselves as a science?
Are there reasons for myths to persist in scientific subjects even though they may represent false beliefs?
What is mythology?
How do myths develop?
How important is mythology to indigenous knowledge systems?
What are the strengths and weaknesses of mythology as a source of knowledge in indigenous knowledge?
Does mythology exist in areas of knowledge that you study in the IB?
Does this pose a problem in subjects that refer to themselves as a science?
Are there reasons for myths to persist in scientific subjects even though they may represent false beliefs?
The QWERTY myth
Economists adore a nice case of market failure. The dogged persistence of the standard typewriter keyboard, held to be a technological anachronism, is a great favourite. Yet the charges against QWERTY were long ago disproved AT A conference attended the other day by your reporter, a distinguished academic economist (who had better remain nameless) cited the "QWERTY" layout of the standard typewriter keyboard as a clear example of how markets "can make mistakes".
Solutions to market Failure
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ETS/TRADEABLE PERMITS/CAP AND TRADE SCHEMES (ALL THE SAME THING)
SUBSIDY INDIRECT-TAX CONSUMER NUDGES PUBLIC AWARENSS CAMPAIGNS REGULATION MANDATE DIRECT PROVISION CONSUMER SOVERIGNTY |
Milton Friedman: A Neo-classical perspective on Market Failure and solutions to Market Failure
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Robert Reich and Paul Krugman: A progressive perspective on Market Failure and solutions to Market Failure
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| policy_prescriptions.docx |
Common pool or Common access resources
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RIVALROUS
NON-EXCLUDABLE TRAGEDY OF THE COMMONS (GARRETT HARDIN) ELINOR OSTROOM SUSTAINABILITY |
- Describe, using examples, common pool/common access resources.
- Describe sustainability.
- Explain that the lack of a pricing mechanism for common access resources means that these goods may be overused/depleted/degraded as a result of activities of producers and consumers who do not pay for the resources that they use, and that this poses a threat to sustainability.
- Explain, using negative externalities diagrams, that economic activity requiring the use of fossil fuels to satisfy demand poses a threat to sustainability.
- Explain that the existence of poverty in economically less developed countries creates negative externalities through over-exploitation of land for agriculture, and that this poses a threat to sustainability.
- Evaluate, using diagrams, possible government responses to threats to sustainability, including legislation, carbon taxes, cap and trade schemes, and funding for clean technologies.
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A simple explanation of the Tragedy of the Commons from Khan Academy
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The tragedy of the high seas
IN 1968 an American ecologist, Garrett Hardin, published an article entitled "The Tragedy of the Commons". He argued that when a resource is held jointly, it is in individuals' self-interest to deplete it, so people will tend to undermine their collective long-term interest by over-exploiting rather than protecting that asset.
Question: What distinguishes the economists approach to that of the environmentalist to CAR's?
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Task: Watch the short film about Economist Elinor Ostrom or read through the obituary below:
Brainstorm the main features of her ideas and then ponder the following quotation:
"Mrs Ostrom, besides poring over satellite data and quizzing lobstermen herself, enjoyed employing game theory to try to predict the behaviour of people faced with limited resources."
Activity: Create a 'game' that demonstrates Tragedy of the Commons Theory and utilizes a game payout matrix. For ideas read pages 201-203 on the use of Game Theory in Oligopolistic Markets.
What insights does Game Theory reveal about the nature of Common Access Resources and the threat to them?
Brainstorm the main features of her ideas and then ponder the following quotation:
"Mrs Ostrom, besides poring over satellite data and quizzing lobstermen herself, enjoyed employing game theory to try to predict the behaviour of people faced with limited resources."
Activity: Create a 'game' that demonstrates Tragedy of the Commons Theory and utilizes a game payout matrix. For ideas read pages 201-203 on the use of Game Theory in Oligopolistic Markets.
What insights does Game Theory reveal about the nature of Common Access Resources and the threat to them?
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Assymetric Behavior
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INFORMED AND UNINFORMED PARTIES
ADVERSE SELECTION 'MARKET FOR LEMONS' GEORGE AKELOV SCREENING AND SIGNALING MORAL HAZARD |
- Explain, using examples, that market failure may occur when one party in an economic transaction (either the buyer or the seller) possesses more information than the other party.
- Evaluate possible government responses, including legislation, regulation and provision of information.
Thinker: Holiday gift giving; why might an Econ view this as a form of market failure?
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Who had more information Ralphy or Aunt Clara?
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| copy_of_asymmetric_information.docx |
MORAL HAZARD
Should the Fidelity Fiduciary Bank receive a government bailout???
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ACTIVITY: Read the following article from the Economist explaining why the banking sector is rife with Asymmetric Information, Adverse Selection, Moral Hazard and how intervention by governments can only partially resolve the problem.
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| banks_and_asymmetric_behavior.docx |
abuse of mONOPOLY power
- Explain how monopoly power can create a welfare loss and is, therefore, a type of market failure.
- Discuss possible government responses, including legislation, regulation, nationalisation and trade liberalisation.
Imperfect markets refer to those markets in which firms have some price setting ability. In these situations, consumers have less power to switch away from particular firms, either because there is only a single firm (in the case of a monopoly
Examples of abuse of monopoly power include:
In an imperfect market profits will be maximised when the marginal cost equals marginal revenue (MC = MR). Here the firm's private costs is the same as supply and MSC. They can maximise profits because the additional revenue gained from the sale of an additional unit equal that unit's additional cost, and so profits have stopped growing and reached their maximum level. This results in a lower output, Q1, sold at a price P, as shown in Figure 1. This price is higher than would be optimal at MSC=MSB. As Q* is not reached there is a loss of consumer surplus, which is shown by the yellow triangle, and a loss of producer surplus, shown by the orange triangle. Community surplus is not maximised and therefore there is a market failure.
As the units Q* – Q1 are not produced, even though the MSB is greater than the MSC there is a social welfare loss represented by the sum of both triangles.
Possible government responsesGovernments may try to solve the market failure by ensuring that competitive conditions prevail in markets. They can use:
- The ability to exploit consumer surplus by using price discrimination.
- Charging excessively high prices.
- Collusion – an agreement between firms who hold market power to set higher prices.
- Predatory pricing – setting prices many times below the costs of production to force rival firms out of the market.
In an imperfect market profits will be maximised when the marginal cost equals marginal revenue (MC = MR). Here the firm's private costs is the same as supply and MSC. They can maximise profits because the additional revenue gained from the sale of an additional unit equal that unit's additional cost, and so profits have stopped growing and reached their maximum level. This results in a lower output, Q1, sold at a price P, as shown in Figure 1. This price is higher than would be optimal at MSC=MSB. As Q* is not reached there is a loss of consumer surplus, which is shown by the yellow triangle, and a loss of producer surplus, shown by the orange triangle. Community surplus is not maximised and therefore there is a market failure.
As the units Q* – Q1 are not produced, even though the MSB is greater than the MSC there is a social welfare loss represented by the sum of both triangles.
Possible government responsesGovernments may try to solve the market failure by ensuring that competitive conditions prevail in markets. They can use:
- Legislation
- Regulation
- Nationalisation
- Trade liberalisation
one last thing...
Create a mind-map of all of the market failures we have considered
Ensure that it includes:
DEED
IMPACT ON RESOURCES ALLOCATION
claspp
The American Healthcare market
To what extent is the American Healthcare market an example of Market Failure?