economics (market failure)

market failure

failure of the market to achieve allocative efficiency

types of market failure

overprovision of demerit goods (negative externalities of consumption) underprovision of merit goods (positive externalities of consumption) underprovision of public goods underprovision of positive externalities of production overuse of common access resources threat to sustainability (negative externalities of production) asymmetric information

demerit goods

goods that are bad for the consumer and society as a whole in a free market, demerit goods will be readily available and relatively inexpensive overprovided consumers of these goods are unhealthy, unproductive, and don't contribute to society society has to pay for their healthcare costs

merit goods

goods that benefit the consumer as well as society as a whole in a free market, merit goods will be rare, expensive, and only consumed by the wealthy under-provided educated people are more productive, commit less crimes, pay more taxes, and have jobs, and cost society less in health care

public goods

goods which benefit society and are non excludable and non rivalrous like street lights

non excludable

impossible to prevent someone from using it once its provided

non rivalrous

when someone consumes the good it is still there to be consumed by others

free rider problem

people use public goods without having to pay

quasi public good

goods that don't neatly fit the description of non-rivalrous and non-excludable, but might serve a public good example would be museums

common access resources

essentially free to the user and anyone can get access to the resource rivalrous and non excludable

government intervention

if the free market results in market failure it is the role of the government to interfere

earn government revenue

reason governments may want to intervene earn revenue from indirect taxes by placing them on goods with price inelastic demand

support firms

reason governments may want to intervene aid small firms or firms in areas the government want to grow through subsidies or price floors

support households on low incomes

reason governments may want to intervene support poor households through subsidies or direct provision

influence the level of production

reason governments may want to intervene support firms that produce merit goods through subsidies, price floors

influence the level of consumption

reason governments may want to intervene increase consumption of merit goods and decrease consumption of demerit goods through subsidies or indirect taxes and legislation and regulation

correct market failure

reason governments may want to intervene governments are the only ones that can fix market failure

promote equity

reason governments may want to intervene fix the unequal distribution of wealth that the free market creates

negative externalities

external costs that are paid by a third party (society) due to a financial transaction

negative externalities of production

when there is a cost to the community that is greater than the cost of production paid by the firm MSC is greater than MPC example. production of fossil fuels

welfare loss

when the market is not able to achieve allocative efficiency and community surplus is reduced

positive externalities of production

when there is a benefit to society that is greater than the private benefit of the producer MSC is greater than MPC example. tree farms

negative externalities of consumption

when society would benefit if less of a good or service was consumed MPB is greater than MSB example. drugs, cigarettes

positive externalities of consumption

when there is a benefit to society that is greater than the private benefit of the consumer MSB is greater than MPB example. education

indirect tax (pigouvian)

type of government intervention tax placed on the firm for every unit of output of a good or service firms raise prices and the consumer pays for part of the tax indirectly shifts supply to the left placed on demerit goods shifts supply vertically up or down

carbon tax

type of government intervention indirect tax placed on producers who emit carbon into the atmosphere the more carbon emitted the higher the tax firms raise prices and the consumer pays for part of the tax indirectly

subsidies

type of government intervention payments to a firm to encourage the production of a good or service used for merit goods reduce costs for firms shift supply to the right

government responses to market failure

subsidies indirect taxes carbon taxes tradable permits direct provision contracting private firms price floors price ceilings legislation and regulation education self governance international agreements

tradable permits (cap and trade)

type of government intervention potential solution to carbon emissions and global warming government places a CAP on how much each firm can pollute, firms are issued permits to pollute a certain amount firms who keep their level of pollution under the cap can TRADE their remaining permits to a firm who can't keep their pollution levels under the cap supply is fixed and demand will go down government can reduce the cap, shifting supply to the left and reducing carbon emissions

evaluation of tradable permits

uses the market to solve market failure, supply and demand are set by the price of permits, firms are motivated by profits to reduce emissions cap can be reduced over time, further reducing carbon emissions reduce carbon not the output firms that switch to lower pollution levels with the least expense will do so

what should the cap be? how much is enough pollution? how high do the fines need to be? any fine or tax will increase costs of firms making them less competitive it will take a lot of regulation and policing to enforce this political favoritism is an issue

evaluation of subsidies

increase in consumer and producer surplus government loses money society benefits

evaluation of carbon taxes

reduces consumer and producer surplus government earns money society benefits

evaluation of indirect taxes

reduces consumer and producer surplus government earns money society benefits

direct provision

type of government intervention government directly providing merit goods, public goods

evaluation of direct government provision

consumer surplus increases because they have more goods at little to no cost governments lose because they have to spend time and resources to provide these goods society benefits from these public and merit goods governments are not motivated to keep costs low because there is no profit motive

contracting private firms

type of government intervention governments hire private firms to provided public and merit goods paid for with tax revenue firms bid on contract and government selects the best bid

evaluation of contracting private firms

consumers benefit because consumer surplus increase and live better overall producers benefit because revenue and producer surplus increases government doesn't benefit due to opportunity cost and spending money and resources society benefits because there are more public and merit goods

legislation and regulation

type of government intervention legislation are laws that ban or limit the supply/consumption of a good or service regulation are rules that limit the consumption or production of goods and services can be laws that ban or limit demerit goods educate people on merit goods maintain consumption of common access resources

evaluation of legislation and regulation

consumers and producers of demerit goods are hurt as they loose surplus and revenue consumers and producers of merit goods are helped as they gain surplus and revenue government doesn't benefit as they have to spend more resources to enforce these laws society benefits as society is healthier and more productive

legislation and regulation on demerit goods

legislation and regulation on merit goods

education

type of government intervention using education inititatives

evaluation of education

consumers and producers of demerit goods are hurt as they loose surplus and revenue consumers and producers of merit goods are helped as they gain surplus and revenue government doesn't benefit as they have to spend more resources to enforce these laws society benefits as society is healthier and more productive

international agreements

type of government intervention sustainability and global warming require cooperation of all nations to address some governments place global competition above environmentalism who is gonna monitor and control international agreements

evaluation of international agreements

consumers and producers of demerit goods are hurt as they loose surplus and revenue consumers and producers of merit goods are helped as they gain surplus and revenue government doesn't benefit as they have to spend more resources to enforce these laws society benefits as society is healthier and more productive

collective self governance

type of government intervention everyone works together without government intervention to work: everyone must have a way of communicating with each other and there must be clearly defined boundaries

evaluation of collective self governance

consumers and producers of demerit goods are hurt as they loose surplus and revenue consumers and producers of merit goods are helped as they gain surplus and revenue society benefits as society is healthier and more productive

asymmetric information

when one party in an economic transaction possesses more information than the other party

adverse selection

type of asymmetric information when one party has more information than the other party about the quality of the product

moral hazard

type of asymmetric information when one party takes risks that another party might have to pay for like insurance of financial advisors

government responses to asymmetric information

legislation, warning ads, regulation, provision of information, licensure, screening, signalling

licensure

government response to asymmetric information rules and regulations which require professionals to have a license or certificate to practice

signaling

government response to asymmetric information used by the party with more information (usually the seller) technique in which seller convinces buyers that the product is good quality examples. warranties

screening

government response to asymmetric information method used by the party with less information (usually the buyer) when consumers seek to obtain more information about the product

price ceilings

type of government intervention when the government places a maximum amount that a producer can charge for a good or service designed to protect consumers most common for food and housing needs must be below equilibrium to have an effect requires government subsidies on top of it to work and shifts supply to the right and removes excess demand so that producers and consumers both win

evaluation of price ceilings

shortages and excess demand some consumers get the good at a lower price and some consumers get nothing because of excess demand producers have a reduction in producer surplus and revenue decreases society loses becuse welfare loss is created and too few resources are allocated for production however it might be worth the loss, market failure remains government are losers: either the government doesnt apply subsidies and increases unemployment or government pays for subsidies to eliminate excess demand eliminates price rationing so the development of underground markets may occur

non price rationing

first come first serve distribution of coupons sell to favorite consumers underground markets

price floors

type of government intervention when the government places a minimum amount that a producer can charge for a good or service designed to protect producers most common for essential firms must be above equilibrium to have an effect requires government purchases on top of it to work and shifts supply to the right and removes excess surplus so that producers and consumers both win

evaluation of price floors

surpluses and excess supply consumers are losers: reduction in consumer surplus as price goes up and demand goes down, some consumers will not be able to afford the good producers charge a higher price for their good as price goes up and demand goes down, will not sell much og their goods revenue goes down society loses because welfare loss is created and too many resources are allocated for production however it might be worth the loss, market failure remains government are losers: must buy products from producers to eliminate excess supply, can give excess supply to poor communities, and opportunity cost of the money for surplus